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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K/A
(Mark One)
|X| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 [FEE REQUIRED] For the fiscal year ended December 31, 1999.
OR
| | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 [NO FEE REQUIRED]
For the transition period to
---------------------- ----------------------
Commission file number 1-15389
TRENWICK GROUP INC.
(Exact name of registrant as specified in its charter)
Delaware 06-1152790
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
One Canterbury Green, Stamford, Connecticut 06901
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (203) 353-5500
Securities registered pursuant to Section 12(b) of the Act:
Title of Each Class Name of Each Exchange on Which
Registered
Common Stock, par value $.10 per share New York Stock Exchange
Preferred Stock Purchase Rights New York Stock Exchange
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes |X| No |_|
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. |_|
The aggregate market value on March 24, 2000 of the voting stock held by
non-affiliates of the registrant was $224,696,190.
The number of shares outstanding of each of the issuer's classes of common
stock as of the close of the period covered by this report:
Class Outstanding at March 24, 2000
----- -----------------------------
Common Stock, $.10 par value 16,295,207
Certain portions of the registrant's definitive proxy statement relating to its
annual meeting of stockholders scheduled to be held on May 18, 2000 are
incorporated by reference into Part III of this report and certain portions of
the registrant's annual report to stockholders are incorporated by reference
into Parts II and IV of this report.
<PAGE>
AMENDMENT NO. 1 ON FORM 10-K/A
TO THE
ANNUAL REPORT ON FORM 10-K FOR THE YEAR ENDED DECEMBER 31, 1999
This Amendment No. 1 on Form 10-K/A is being filed to correct a printer
transmission error in the tables listing gross premiums written and net premiums
written on page 2, to include additional disclosure in the second paragraph on
page 12, to revise the classification of certain assets and related cash flows
in the 1999 column in Schedule II - Condensed Financial Information of
Registrant on pages S-1 and S-3, to amend the presentation of certain
information in Schedule V - Valuation and Qualifying Accounts on page S-5, to
revise the Report of Independent Accountants on Financial Statement Schedules on
page S-6 and to revise certain portions of management's discussion and analysis
and footnotes to the financial statements to clarify certain disclosures. The
revised portions of the Annual Report on Form 10-K are set forth in Attachment
A.
<PAGE>
SIGNATURES
Pursuant to the Requirements of Section 13 or 15(d) of Securities Exchange Act
of 1934, the registrant has duly caused this Amendment No. 1 on Form 10-K/A to
be signed on its behalf by the undersigned, thereunto duly authorized.
TRENWICK GROUP INC.
(Registrant)
By /s/ James F. Billett, Jr.
------------------------------
James F. Billett, Jr.
Chairman, President and
Chief Executive Officer
Dated: August 22, 2000
<PAGE>
Attachment A
PART I
Item 1. Business
General Background and History
Trenwick Group Inc. ("Trenwick") is a specialty insurance underwriting
organization with multiple distribution platforms in insurance and reinsurance
operating through its subsidiaries located in the United States and the United
Kingdom. Trenwick's four principal operating units are Trenwick America
Reinsurance Corporation ("Trenwick America Re"), which provides treaty
reinsurance to insurers of property and casualty risks in the United States;
Trenwick International Limited ("Trenwick International"), which underwrites
treaty and facultative reinsurance as well as specialty insurance on a worldwide
basis; Chartwell Managing Agents Limited ("Chartwell Managing Agents"),
Trenwick's managing agency at Lloyd's; and Canterbury Financial Group Inc.
("Canterbury Financial"), which underwrites U.S. property and casualty insurance
through specialty program administrators.
Trenwick was incorporated in the State of Delaware in 1985. Trenwick America Re,
a Connecticut corporation, operated as a subsidiary of Trenwick America
Corporation from 1983 through 1985 and was acquired by Trenwick in 1985 as a
result of a corporate restructuring. Trenwick acquired Trenwick International in
February 1998 and Chartwell Re Corporation ("Chartwell") in October 1999. In
connection with the acquisition of Chartwell, Trenwick acquired Chartwell
Managing Agents, Chartwell Reinsurance Company ("Chartwell Reinsurance"), whose
reinsurance business was assumed by Trenwick America Re, and The Insurance
Corporation of New York ("INSCORP") and Dakota Specialty Insurance Company
("Dakota"), both of which are operating companies for Canterbury Financial. In
addition, Trenwick owns several inactive Bermuda subsidiaries.
On December 19, 1999, Trenwick announced that it had entered into a definitive
agreement to combine with LaSalle Re Holdings Limited, with shareholders of each
company to receive shares in a new Bermuda holding company to be named Trenwick
Group Ltd. This transaction is expected to be completed in the second quarter of
2000.
Each of Trenwick's operating insurance company subsidiaries is rated "A"
(Excellent) by A.M. Best Company and has been assigned an A+ financial strength
rating by Standard & Poor's. All of Chartwell Managing Agents' syndicates enjoy
the benefit of the ratings of Lloyd's, which is rated "A" (Excellent) by A.M.
Best Company and has an A+ claims paying ability rating from Standard & Poor's.
These ratings are based upon factors that may be of concern to policy or
contract holders, agents and intermediaries, but may not reflect the
considerations applicable to an equity investment in a reinsurance or insurance
company. A change in any such rating is at the discretion of the respective
rating agencies.
Trenwick's gross and net premium writings for its operational units are as
follows:
1
<PAGE>
1999 1998 1997
--------------- --------------- ------------
Gross Premiums Written
Trenwick America Re $ 210,921(1) $ 218,249 $ 248,662
Trenwick International 171,698 105,114(2) -
Chartwell Managing Agents 84,834(3) - -
Canterbury Financial 38,088(4) - -
--------------- --------------- ------------
Total $ 505,541 $ 323,363 $ 248,662
=============== =============== ============
Net Premiums Written
Trenwick America Re $ 155,108(1) $ 169,112 $ 195,230
Trenwick International 129,399 81,107(2) -
Chartwell Managing Agents 64,462(3) - -
Canterbury Financial 5,641(4) - -
--------------- --------------- ------------
Total $ 354,610 $ 250,219 $ 195,230
=============== =============== ============
(1) Includes reinsurance business of Chartwell Reinsurance and its subsidiaries
since its acquisition on October 27, 1999.
(2) Includes Trenwick International business since its acquisition on February
27, 1998.
(3) Includes Chartwell Managing Agents business since its acquisition on October
27, 1999.
(4) Includes Canterbury Financial business since its acquisition on October 27,
1999.
Trenwick America Reinsurance Corporation
Trenwick America Re, which comprised 44% of Trenwick's total net premiums
written in 1999, underwrites United States treaty reinsurance, which accounts
for the majority of its business, as well as a small amount of facultative
reinsurance. In this section, Trenwick America Re's 1999 results include the
reinsurance business of Chartwell Reinsurance and its subsidiaries since its
acquisition on October 27, 1999.
Trenwick America Re generally obtains all of its business through brokers and
reinsurance intermediaries which seek its participation on reinsurance being
placed for their customers. In underwriting reinsurance, Trenwick America Re
does not target types of clients, classes of business or types of reinsurance.
Rather, it selects transactions based upon the quality of the reinsured, the
attractiveness of the reinsured's insurance rates and policy conditions and the
adequacy of the proposed reinsurance terms.
Trenwick America Re's commitment is currently limited to $2,500,000 per contract
on casualty treaty business and $1,500,000 on property business. Larger
commitments are subject to Trenwick's Underwriting Committee referral process.
2
<PAGE>
Trenwick America Re's net premiums written by line of business are set forth in
the following table for the periods indicated.
Trenwick America Reinsurance Corporation
Net Premiums Written By Lines of Business
(in thousands)
1999(1) 1998 1997
---------------- -------------- -----------
Casualty
Automobile Liability $ 17,831 $ 51,299 $ 50,187
Errors and Omissions 45,557 36,655 40,063
General Liability 22,170 17,743 20,795
Accident and Health 17,922 11,014 6,326
Medical Malpractice 3,422 7,700 10,293
Workers' Compensation 8,297 3,025 18,328
Products Liability 1,834 2,312 1,743
Other Casualty 12,431 2,697 9,133
---------------- -------------- -----------
Total Casualty 129,464 132,445 156,868
---------------- -------------- -----------
Property 25,644 36,667 38,362
---------------- -------------- -----------
Total $ 155,108 $ 169,112 $ 195,230
================ ============== ===========
(1)Includes reinsurance business of Chartwell Reinsurance and its subsidiaries
since its acquisition on October 27, 1999.
The major lines of reinsurance currently written by Trenwick America Re are
automobile liability, errors and omissions, general liability and accident and
health. Together these lines account for an aggregate of at least 67% of its net
premiums written in all years indicated. The overall decline in net premiums
written since 1997 is a result of three principal causes. Competition among
primary companies has caused cedants to reduce their own premium writings or
restructure their reinsurance programs, reducing the amount of reinsurance they
purchase. As a result of consolidation within the industry, many ceding
companies are now larger and financially stronger, enabling them to retain more
risk. In addition, increasingly intense competition in the reinsurance markets
has driven reinsurance prices on a number of accounts below pricing levels which
Trenwick America Re will accept. The 65% decline in automobile liability net
premium writings in 1999 resulted from the non-renewal of two significant
accounts, one of which was commuted in the fourth quarter of 1999. Accident and
health net premiums written increased by 63% compared to 1998 as a result of
Trenwick America Re's strategic alliance with Duncanson and Holt. This account
was non-renewed in 2000 following the sale of Duncanson and Holt. In 1999, the
amount of property business, including automobile physical damage, underwritten
by Trenwick America Re remained constant as a percentage of total net written
premiums.
Three ceding companies accounted for approximately 25%, 38%, and 32% of Trenwick
America Re's gross premiums written in 1999, 1998 and 1997, respectively. During
1999, Duncanson and Holt, American International Group and CNA Insurance
Companies accounted for 11%, 7% and 7%, respectively, of Trenwick America Re's
gross premiums written. While Trenwick America Re believes that the loss of
these accounts will not have a material adverse effect on the business and
operations of Trenwick, Trenwick does not believe that such a loss would have a
long-term adverse effect because of Trenwick's competitive position within the
reinsurance market and the availability of business from other brokers and
ceding companies. Further, Trenwick believes that it will continue to underwrite
new business to replace the accounts.
3
<PAGE>
Trenwick International Limited
Trenwick International's business, which accounted for 36% of Trenwick's total
net premiums written in 1999, consists principally of insurance and facultative
reinsurance of specialty classes. Trenwick International also underwrites
property and casualty treaty reinsurance. In the latter part of 1998, Trenwick
International opened a branch office in Paris which specializes in facultative
reinsurance of large, technically complex property risks. Premiums written by
the Paris branch in 1999 were not material.
Trenwick International also obtains all of its business through brokers.
Trenwick International's business consists of Specialist Risk Underwriting
("SRU") which includes direct insurance, facultative reinsurance and treaty
reinsurance. The following table reflects Trenwick International's net premiums
written by type of business for 1999 and 1998.
International Net Premiums Written By Type of Business
(dollars in thousands)
1999 1998
------------------------------ ----------------------------
SRU 98,926 76 % 83,397 83 %
Treaty 30,473 24 % 17,385 17 %
-------------- ------------ -------------- -----------
Total $ 129,399 100 % 100,782 100 %
============== ============ ============== ===========
Specialist Risk Underwriting
SRU underwrites business in both London and Paris. Trenwick's branch office in
Paris was opened in September of 1998. The principal lines of business
underwritten in 1999 and 1998 include property, engineering, accident and health
professional indemnity, financial institutions, liability, extended warranty and
yacht hull. In 1999, approximately 53% of Trenwick International's net premiums
were written directly as insurance.
Trenwick's Paris branch specializes in large, complex property risks that
require a high degree of underwriting expertise. Trenwick International
generally underwrites this business, which includes large manufacturing
facilities, construction projects as well as both onshore and offshore energy
risks, as facultative reinsurance, but can also function directly as an insurer.
The Paris branch benefits from a pool of underwriters trained as engineers and
has emerged as a center for this type of technical underwriting.
Treaty
Trenwick International's treaty business includes liability business, which
accounted for approximately 51% of treaty business in 1999, as well as property
and credit business. Treaty is written both on a proportional and
non-proportional basis.
4
<PAGE>
Chartwell Managing Agents
Trenwick participates in the Lloyd's market through Chartwell Managing Agents,
which is a managing agent at Lloyd's and through four Lloyd's corporate members.
Chartwell Managing Agents receives fees and profit commissions in respect of the
underwriting and administrative services it provides to the Lloyd's underwriting
syndicates that it manages. For the 2000 year of account, Chartwell Managing
Agents manages three syndicates with a total underwriting capacity of
approximately $377.1 million. In 1998 and 1999, Chartwell Managing Agents sold
to third parties the rights to manage syndicates 866 (motor), 947 (non-marine)
and 994 (non-marine) and combined into a single syndicate for the 2000 year of
account the remaining non-life syndicates. Trenwick retains the benefits and
obligations with respect to its Lloyd's corporate member participation interests
in those syndicates for the open years of account at the time of the sale.
Trenwick's Lloyd's corporate members participated on three Lloyd's syndicates
for the 2000 year of account, providing an aggregate of approximately $350.1
million of capacity to those syndicates. Approximately 93% of Chartwell Managing
Agents syndicates' 2000 year of account capacity was supplied by Trenwick.
Classes of business covered by Chartwell Managing Agents' syndicates include
marine, non-marine property, non-marine liability, motor, aviation and life. The
table set forth below shows the gross premiums written for Trenwick's Lloyd's
corporate members for the periods indicated. All amounts in the table below are
presented in accordance with U.S. generally accepted accounting principles
("GAAP").
Trenwick's Lloyd's Corporate Members
Gross Premiums Written by Lloyd's Market Segment
(dollars in thousands)(1)
Year Ended December 31,
----------------------------------------------
1999 1998
----------------------- --------------------
Amount % of Total Amount % of Total
---------- ----------- ---------- ---------
Motor........................ $ 37,370 17.7% $ 36,212 49.9%
Non-Marine................... 140,337 66.5 31,121 42.9
Aviation..................... 19,802 9.4 3,194 4.4
Marine....................... 12,350 5.9 1,757 2.4
Life......................... 1,092 .5 289 0.4
---------- ----------- ---------- ---------
Total........................ $ 210,951 100.0 % $ 72,573 100.0%
========== =========== ========== =========
(1) Business at Lloyd's is conducted in pounds sterling. The dollar amounts
shown here have been converted from pounds sterling at the average exchange rate
for each of the years presented. Data shown for 1998 and that portion of 1999
prior to October 27, 1999 is not included in Trenwick's financial statements
because Trenwick acquired Chartwell Managing Agents and its related Lloyd's
corporate members on October 27, 1999.
Canterbury Financial Group
Canterbury Financial Group develops insurance programs through specialty
production sources with a focus on a specific line or lines of business, with a
limited geographic emphasis, and where the program administrator's compensation
is adjusted based on the underwriting results of the business. Canterbury
Financial Group evaluates each business relationship based upon the underwriting
experience and operational expertise of the production source. Canterbury
Financial Group periodically performs underwriting, claims and operational
audits of each of its production sources.
Canterbury Financial Group's gross written premiums grew 32.7%, 4.3% and 81.3%
for the years ended December 31, 1999, 1998 and 1997, respectively, over the
prior year. The increases in premium reflect the geographic expansion of
existing programs as well as the development of new programs during the periods
shown.
5
<PAGE>
The table set forth below shows the gross premiums written for Canterbury
Financial Group for the periods indicated:
<TABLE>
<CAPTION>
Canterbury Financial Group
Gross Premiums Written by Line of Business
(dollars in thousands)(1)
Year Ended December 31,
-------------------------------------------------------------------------------
1999 1998 1997
------------------------ ------------------------- ------------------------
Amount Total Amount Total Amount Total
----------- ----------- ----------- ----------- ----------- -----------
<S> <C> <C> <C> <C> <C> <C>
Commercial Multiple Peril......$ 41,909 28.4% $ 45,737 41.2% $ 48,404 45.4 %
General Liability.............. 36,743 25.0 31,575 28.4 30,418 28.6
Automobile..................... 46,471 31.5 23,354 21.0 22,267 20.9
Workers Compensation........... 12,589 8.5 4,224 3.8 4,169 3.9
Homeowners and Other........... 9,786 6.6 6,241 5.6 1,285 1.2
------------ ----------- ----------- ----------- ----------- -----------
Total..........................$ 147,498 100.0% $ 111,131 100.0% $ 106,543 100.0 %
============ =========== =========== =========== =========== ===========
</TABLE>
(1) Data shown for 1998 and that portion of 1999 prior to October 27, 1999 is
not included in Trenwick's financial statements because Trenwick acquired
Canterbury Financial on October 27, 1999.
During the year ended December 31, 1999, Canterbury Financial Group underwrote
approximately 64% of its gross premiums through three managing general agents,
of which Florida Intracoastal Underwriters accounted for approximately 31%, HDR
Insurance Services accounted for approximately 22% and Inter-Reco accounted for
approximately 11%. No other managing general agent accounted for more than 10%
of Canterbury Financial Group's gross insurance premiums written for such
period.
In order to reduce the potential adverse effect arising from the termination of
any specific business relationship, Canterbury Financial Group continues to seek
to establish and develop relationships with a large number of managing general
agents. While management believes that its relationships with its managing
general agents are satisfactory, the termination of all or a substantial number
of these relationships could have a material adverse effect on the business and
operations of Canterbury Financial Group.
Marketing
Trenwick generally obtains its business through insurance and reinsurance
brokers which represent the ceding company and clients in negotiations for the
purchase of insurance or reinsurance. The process of effecting a brokered
placement typically begins when a client or ceding company enlists the aid of a
broker in structuring an insurance or reinsurance program. Often the various
parties will consult with one or more lead underwriters as to the pricing and
contract terms of the protection being sought. Once the terms quoted by the lead
underwriter have been approved, the broker will offer participation to qualified
insurers or reinsurers until the program is fully subscribed at terms agreed to
by all parties.
6
<PAGE>
Trenwick pays such intermediaries or brokers commissions representing negotiated
percentages of the premium it writes. These commissions constitute part of
Trenwick's total acquisition costs and are included in its underwriting
expenses. Brokers do not have the authority to bind Trenwick America Re with
respect to agreements. Under certain limited circumstances, selected
administrators have the authority to bind Trenwick International, Chartwell
Managing Agents and Canterbury Financial Group business. These administrators
are subject to periodic financial and operational reviews. Trenwick does not
commit in advance to accept any portion of the business that brokers submit to
it. Business from any company, whether new or renewal, is subject to acceptance
by Trenwick.
During 1999, three reinsurance brokers, AON Reinsurance Agency, Guy Carpenter
and E. W. Blanch generated 37%, 16% and 8%, respectively, of Trenwick America
Re's gross written premiums. These brokers are among the ten largest brokers in
the insurance and reinsurance industry. Loss of all or a substantial portion of
the business provided by Trenwick's brokers could have a material adverse effect
on the business and operations of Trenwick. Trenwick does not believe, however,
that the loss of such business would have a long-term adverse effect because of
Trenwick's competitive position within the broker insurance and reinsurance
market and the availability of business from other brokers.
Underwriting
Trenwick's underwriting philosophy emphasizes a transactional approach to
underwriting in which any insurance or reinsurance transaction for any line of
property or casualty business is considered on its own merits. The underwriter's
primary objective is to assess the potential for an underwriting profit. The
risk assessment process undertaken by Trenwick's underwriters involves a
comprehensive analysis of historical data, when available, and estimates of
future value of loss costs which may not be evident in the historical data. The
factors which Trenwick considers include the type of risk, details of the
underlying insurance coverage provided, adequacy of pricing using actuarial
analysis and the terms and conditions. With respect to its domestic operations
which comprises fewer but significantly larger accounts, Trenwick frequently
conducts underwriting and claims audits of ceding companies to assist it in
evaluating the information submitted by the ceding companies, before agreeing to
participate in a reinsurance transaction.
Trenwick has established formal underwriting policy standards for both domestic
and international operations. This process involves pre-binding reviews of
individual material transactions by its senior underwriting staff. Underwriting
policies for insurance and reinsurance transactions are supplemented by
conducting periodic internal audits of each underwriting department to ensure
compliance with underwriting policies and procedures.
Competition
Trenwick competes with numerous major international and domestic insurance and
reinsurance companies. These competitors, many of which have substantially
greater financial and staff resources than Trenwick, include independent
insurance and reinsurance companies, subsidiaries or affiliates of established
insurance companies, reinsurance departments of certain commercial insurance
companies and underwriting syndicates.
Competition in the types of business which Trenwick underwrites is based on many
factors. These factors include the perceived overall financial strength of the
insurer or reinsurer, rates charged, other terms and conditions, agency ratings
(including A.M. Best Company and Standard & Poor's), service offered, speed of
service (including claims payment) and perceived technical ability and
experience of staff. The number of jurisdictions in which an insurer or
reinsurer is licensed or authorized to do business is also a factor.
7
<PAGE>
The financial security of insurers and reinsurers has emerged as a key issue
throughout the 1990's. To be accepted by clients, and by ceding companies and
their brokers, insurers and reinsurers must demonstrate higher levels of
financial security and solvency than were previously required. Transactions tend
to have fewer and larger participants, which may negatively affect the
availability of underwriting opportunities for Trenwick.
Trenwick's management believes that the insurance and reinsurance industry,
including the broker market, will continue to undergo further consolidation and
that size and financial strength will continue to be significant factors in
effective competition.
Claims Administration
Claims are managed by Trenwick's professional claims staff whose
responsibilities include the review of initial loss reports, creation of claim
files, determination of whether further investigation is required, establishment
and adjustment of case reserves and payment of claims. In addition, the claims
staff conducts comprehensive claims audits of both specific claims and overall
claims procedures at the offices of selected brokers and ceding companies. In
certain instances, a claims audit may be performed prior to assuming reinsurance
business as part of a comprehensive risk evaluation process. For insurance
business, Trenwick's claim staff uses their own judgement as well as advice from
lawyers and loss adjusters where appropriate.
In connection with the acquisition of Chartwell, Trenwick acquired an
environmental claims unit to evaluate the complex toxic tort and latent injury
claims resident in one of Chartwell's subsidiaries, The Insurance Corporation of
New York.
Unpaid Claims and Claims Expenses
General
Insurers and reinsurers establish claims and claims expense reserves
representing estimates of future amounts needed to pay claims and related
expenses with respect to insured events which have occurred. Claims and claims
expense reserves have two components: case reserves, which are reserves for
reported claims, and incurred but not reported ("IBNR") reserves, which are
reserves for claims not yet reported. Significant periods of time may elapse
between the occurrence of an insured claim, the reporting of the claims to the
insurer and the subsequent reporting of the claims to the reinsurer, the
insurer's payment of that claim, and later payments by the reinsurer.
Trenwick first establishes its case reserves for reported claims when it
receives notice of the claim. It is Trenwick's policy to establish reserves for
reported claims in an amount equal to the greater of the reserve recommended by
the ceding company or the claim as estimated by Trenwick's claims personnel.
Trenwick periodically conducts investigations to determine if the amount
reserved by the ceding company is appropriate or should be adjusted. During the
claim settlement period, which may be many years, additional facts regarding
individual claims may become known. As Trenwick learns additional facts, it may
become necessary to refine and adjust upward or downward the estimated reserves
on a claim, and even then the ultimate net reserve may be less than or greater
than the revised estimates. Trenwick does not discount any of its reserves for
reported or unreported claims in any line of its business for anticipated
investment income.
8
<PAGE>
Actuarial Methods
Trenwick utilizes the two most common methods of actuarial evaluation used
within the insurance industry, the Bornhuetter-Ferguson method and the loss
development method. The Bornhuetter-Ferguson method involves the application of
selected loss ratios to Trenwick's earned premiums to determine estimates of
ultimate expected loss and loss adjustment expenses for each underwriting year.
Multiplying expected losses by underwriting year by a selected loss reporting
pattern gives an estimate of reported and unreported IBNR losses. When the IBNR
is added to the loss and loss adjustment expense amounts with respect to claims
that have been reported to date, an estimated ultimate expected loss results.
This method provides a more stable estimate of IBNR that is insulated from wide
variations in reported losses. In contrast, the loss development method
extrapolates the current value of reported losses to ultimate expected losses by
using selected reporting patterns of losses over time. The selected reporting
patterns are based on historical information (organized into loss development
triangles) and are adjusted to reflect the changing characteristics of the book
of business written by Trenwick.
Trenwick provides capital to its Lloyd's corporate members, which support the
underwriting capacity of the Lloyd's syndicates managed by Chartwell Managing
Agents. Loss reserves for this business are established using methods similar to
those used by Trenwick for its operating insurance company subsidiaries.
Chartwell Managing Agents has engaged Bacon & Woodrow London Market Services
Ltd. ("B&W"), an independent actuarial consulting firm, to review the loss
reserves and prepare an actuarial opinion for each of its syndicates, including
the actuarial opinion required by Lloyd's solvency regulations. The B&W
opinions, which are prepared solely for the use of Lloyd's regulators and are
only to be relied upon by Chartwell Managing Agents, assist its syndicates in
establishing appropriate reserve estimates for both the reinsurance to close and
the open years of account.
In the reserve setting process, Trenwick includes provisions for inflation and
"social inflation" if appropriate, as losses are generally not determined until
some time in the future. Trenwick continually monitors legislative activity and
evaluates the potential effect of any legislative changes on its reserve
liabilities.
Trenwick's reserves are carried at the full amount estimated for ultimate
expected losses and loss adjustment expense without any discount to reflect the
time value of money in accordance with both statutory accounting practices and
GAAP. Trenwick's actuarial department regularly performs loss reserve analyses
for its operating insurance company subsidiaries.
9
<PAGE>
Reserve Analysis
The following table presents the development of Trenwick's net unpaid claims and
claims expenses for 1989 through 1999. The top line of the table shows the net
unpaid claims and claims expenses at the balance sheet date for each of the
indicated years. This reflects the net estimated amounts of claims and claims
expenses for claims arising in that year and in all prior years that are unpaid
at the balance sheet date, including claims that had been incurred but not yet
reported to Trenwick. The upper portion of the table shows the net cumulative
subsequently paid amounts as of successive years with respect to that liability.
The middle portion of the table shows the net re-estimated amount of the
previously recorded net unpaid claims and claims expenses based on experience as
of the end of each succeeding year. The estimates change as more information
becomes known about the frequency and severity of claims for individual years. A
redundancy (deficiency) exists when the net re-estimated liability at each
December 31 is less (greater) than the prior net liability estimate. The net
"Cumulative Redundancy (Deficiency)" depicted in the table for any particular
calendar year represents the aggregate change in the initial net estimates over
all subsequent calendar years.
The lower portion of the table presents a reconciliation of the net unpaid
claims and claims expenses as of the end of the year with the related gross
unpaid claims and claims expenses as of December 31, 1991 through 1999.
Additionally, the table presents a reconciliation of the gross re-estimated
unpaid claims and claims expenses as of the end of the latest re-estimation
year, with separate disclosure of the related re-estimated reinsurance
recoverable on unpaid claims and claims expenses. The "gross cumulative
redundancy" depicted in the table for the calendar years 1991 through 1999
represents the aggregate change in the initial gross estimates over all
subsequent calendar years.
10
<PAGE>
DEVELOPMENT OF UNPAID CLAIMS AND CLAIMS EXPENSES
(in thousands)
<TABLE>
<CAPTION>
----------------------------------------------------------------------------------------------------------------------------------
1999 1998 1997 1996 1995 1994 1993 1992
----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Net unpaid claims and claims
expenses, end of year $1,207,436 $449,264 $ 379,351 $386,887 $327,001 $294,008 $268,091 $266,685
Cumulative amount of net
liability paid as of:
One year later 172,674 104,718 94,197 46,860 61,804 52,300 52,260
Two years later 194,188 162,565 110,289 81,417 90,382 93,312
Three years later -- 215,803 149,810 121,133 89,445 118,345
Four years later -- -- 178,919 142,485 112,119 111,174
Five years later -- -- -- 156,204 124,096 125,847
Six years later -- -- -- -- 134,535 133,502
Seven years later -- -- -- -- -- 139,779
Eight years later -- -- -- -- -- --
Nine years later -- -- -- -- -- --
Ten years later -- -- -- -- -- --
Net liability re-estimated as of:
One year later 463,892 372,176 381,521 322,562 291,943 267,644 255,379
Two years later 383,584 374,336 317,199 279,561 263,473 255,379
Three years later 381,463 308,700 274,283 246,367 252,458
Four years later -- -- 309,282 265,041 241,478 236,009
Five years later -- -- -- 266,583 229,742 230,488
Six years later -- -- -- -- 230,824 222,094
Seven years later -- -- -- -- -- 223,473
Eight years later -- -- -- -- -- --
Nine years later -- -- -- -- -- --
Ten years later -- -- -- -- -- --
Net cumulative redundancy (deficiency) (14,628) (4,233) 5,424 17,719 27,425 37,267 43,212
Percentage (1)% 1% 5% 9% 14% 16%
Gross Liability, end of year 682,428 518,387 467,177 411,874 389,298 354,582 351,897
Reinsurance recoverable 233,164 139,036 80,290 84,873 95,290 86,491 85,212
Net liability, end of year 449,264 379,351 386,887 327,001 294,008 268,091 266,685
Gross re-estimated liability-latest 719,143 521,011 462,384 393,765 339,514 293,613 288,355
Re-estimated recoverable-latest 255,251 137,427 80,921 84,483 72,931 62,789 64,882
Net re-estimated liability-latest 463,892 383,584 381,463 309,282 266,583 230,824 223,473
Gross cumulative redundancy (deficiency) (36,715) (2,624) 4,793 18,109 49,784 60,969 63,542
<CAPTION>
--------------------------------------------------------------------------
1991 1990 1989
--------------------------------------------------------------------------
<S> <C> <C> <C>
Net unpaid claims and claims
expenses, end of year $258,774 $245,105 $214,391
Cumulative amount of net
liability paid as of:
One year later 44,930 42,234 29,407
Two years later 80,725 77,183 60,888
Three years later 111,225 102,590 84,283
Four years later 127,431 124,129 101,597
Five years later 116,224 134,657 116,047
Six years later 127,130 122,089 124,465
Seven years later 132,194 129,100 110,656
Eight years later 137,401 132,888 115,017
Nine years later -- 136,959 117,364
Ten years later -- -- 120,895
Net liability re-estimated as of:
One year later 253,781 238,324 206,724
Two years later 243,488 233,565 199,864
Three years later 243,586 223,417 196,232
Four years later 241,600 224,171 188,052
Five years later 225,592 223,172 189,148
Six years later 217,852 213,327 188,884
Seven years later 208,701 205,179 180,619
Eight years later 211,487 199,948 176,778
Nine years later -- 202,578 172,846
Ten years later -- -- 175,362
Net cumulative redundancy (deficiency) 47,287 42,527 39,029
Percentage 18% 17% 18%
Gross Liability, end of year 332,503
Reinsurance recoverable 73,729
Net liability, end of year 258,774
Gross re-estimated liability-latest 268,217
Re-estimated recoverable-latest 56,730
Net re-estimated liability-latest 211,487
Gross cumulative redundancy (deficiency) 64,286
</TABLE>
11
<PAGE>
In evaluating the information in the table on the preceding page, it should be
noted that each amount includes the effects of all changes in amounts for prior
periods. For example, if a claim determined in 1991 to be $150,000 was first
reserved in 1986 at $100,000, the $50,000 deficiency (actual claim minus
original estimate) would be included in the gross cumulative redundancy
(deficiency) in each of the years 1986-1991 shown on the preceding page. This
table does not present accident or policy year development data. Conditions and
trends that have affected the development of liability in the past may not
necessarily occur in the future. Accordingly, it may not be appropriate to
extrapolate future redundancies or deficiencies based on this table.
The trend depicted in the table indicates that net unpaid claims and claims
expense liability at December 31, 1998 have developed unfavorably due to
Trenwick America Re's unfavorable development for claims occurring in accident
years 1996 through 1998. Net unpaid claims and claims expenses at December 31,
1999 includes reinsurance recoverable of $46,460,000 under the adverse
development cover purchased by Chartwell in connection with its acquisition by
Trenwick. For further discussion of unpaid claims and claims expenses, see Notes
4 and 5 of Notes to the Consolidated Financial Statements of Trenwick.
Management believes that Trenwick's reserves are adequate. However, the process
of estimating reserves is inherently imprecise and involves an evaluation of
many variables, including potentially unpredictable social and economic
conditions. Accordingly, there can be no assurance that Trenwick's ultimate
liability will not vary significantly from amounts reserved. The inherent
uncertainties of estimating such reserves are greater for reinsurers than for
primary insurers, primarily due to the longer-term reporting nature of the
reinsurance business, the diversity of development patterns among different
types of reinsurance, the necessary reliance on ceding companies for information
regarding reported claims and differing reserving practices among ceding
companies. Reserves also include provisions for latent injury or toxic tort
claims that cannot be estimated with traditional reserving techniques. Due to
inconsistent court decisions in federal and state jurisdictions and the wide
variation among insureds with respect to underlying facts and coverage,
uncertainty exists with respect to these claims as to liabilities of ceding
companies and, consequently, reinsurance coverage. Management believes that
Trenwick's exposure to such latent losses is lessened because of its relatively
recent entry into the reinsurance business (other than INSCORP), its low
historical levels of premium volume prior to the application of exclusions for
asbestos and environmental liabilities, its retrocessional programs and the
protection afforded by Trenwick's Contingent Interest Notes due June 30, 2006
(the "Contingent Interest Notes") the payment of which is subject to reduction
in the event of such adverse reserve development related to INSCORP's business.
Reserves for Trenwick's participation in Lloyd's syndicates through its Lloyd's
corporate members are included in the 1999 year end reserves. Part of the
reserve represents reinsurance to close balances brought forward to the open
years of account (for example, 1996 reinsured into the 1997 open year).
Favorable or unfavorable development of the prior year's reserves can influence
the results of the open years of 1997, 1998 and 1999. Consequently, there can be
no assurance as to the adequacy of reserves and the risk of future developments,
both favorable and unfavorable, exists.
12
<PAGE>
Trenwick's reserves include an estimate of Trenwick's ultimate liability for
asbestos and environmental claims. The gross and net unpaid claims and claims
expenses for asbestos and environmental claims are as follows:
1999 1998 1997
--------- -------- ---------
(in thousands)
Unpaid claims and claims expenses gross of
reinsurance recoverable, end of year $ 100,131 $ 8,476 $ 8,924
Unpaid claims and claims expenses, net of
reinsurance recoverable, end of year 72,092 8,428 8,814
Reinsurance recoverable on unpaid claims and
claims expenses, end of year 28,039 48 110
The increase of the gross and net unpaid claims and claims expenses reflect the
inclusion of the reserves related to the Chartwell acquisition. Under Trenwick's
current interpretation of policy language, management does not believe that it
has a material exposure to environmental claims that requires additional
reserves beyond its current estimates.
Contingent Interest Notes
Upon consummation of the acquisition of Chartwell, Trenwick assumed all of
Chartwell's obligations under the Contingent Interest Notes, which were
originally issued by Piedmont Management Company Inc. to its stockholders just
prior to its acquisition by Chartwell in 1995. The Contingent Interest Notes,
which mature on June 30, 2006, are designed to provide Trenwick with protection
against adverse development of INSCORP's reserves for losses and loss adjustment
expenses. In the event there is no adverse development, Trenwick will be
required to pay the holders of the CI Notes approximately $55 million in
contingent interest. This contingent interest payment is in addition to the $1
million principal amount of the Contingent Interest Notes and interest on such
principal amount at 8% per annum (collectively, the "Fixed Amount") which
Trenwick in any event must pay at maturity or earlier redemption of the
Contingent Interest Notes.
In general, assuming the Contingent Interest Notes are settled at maturity, the
contingent interest will be equal to $55 million (a) less an amount equal to (i)
the amount of any adverse development of the loss and loss adjustment expense
reserves and related accounts (including certain reinsurance recoverable,
commissions and unearned premiums) of INSCORP recorded as of March 31, 1995,
minus (ii) $25 million, (b) plus the amount of certain tax benefits received or
recorded by Trenwick as a result of the amount determined pursuant to clause (a)
above. The amount so calculated may not be greater than $55 million nor less
than a minimum amount equal to the lesser of (a) $10 million less the Fixed
Amount and (b) the tax benefits referred to above. In the event that the
Contingent Interest Notes are settled prior to maturity, the foregoing formula
will in general apply, except that the $55 million maximum amount of the
Contingent Interest Notes will be reduced to an amount equal to $55 million
discounted back from June 30, 2006 at a discount rate of 8% per annum,
compounded annually, and the tax benefits will be calculated in a prescribed
manner.
The carrying value of the Contingent Interest Notes on Trenwick's consolidated
financial statements at December 31, 1999 was $34.7 million, representing the
sum of the aggregate principal amount of the Contingent Interest Notes and the
present value as of such date of the maximum amount of contingent interest
payable on the Contingent Interest Notes at their stated maturity in 2006.
13
<PAGE>
During the term of the Contingent Interest Notes, the discounted carrying value
of the Contingent Interest Notes will be increased to reflect accretion of (i)
interest on the principal amount and (ii) the discounted contingent interest. To
the extent that adverse development of INSCORP's reserves (including IBNR
reserves) occurs prior to the maturity or redemption of the Contingent Interest
Notes, the contingent interest payable on the Contingent Interest Notes (and,
therefore, the then-current carrying value of such Contingent Interest Notes)
will be reduced. Such reductions in the carrying value of the Contingent
Interest Notes would offset in part, in the period in which such adverse
development occurs, any reduction in Trenwick's GAAP net income and
stockholders' equity resulting from such adverse reserve development (that
would, however, still be reflected in Trenwick's statutory underwriting results
and in the policyholders' surplus of INSCORP and any parent insurer of INSCORP).
At its option, Trenwick may settle the Contingent Interest Notes with shares of
common stock of Trenwick instead of payment of cash. For purposes of settlement
of the Contingent Interest Notes, such common stock would be valued at 85% of
its average closing market price over a specified period prior to the settlement
date. However, Trenwick may not settle the Contingent Interest Notes in its
common stock unless (i) such stock is registered under the Securities Act of
1933 (or is otherwise freely tradeable other than by certain affiliates of
Trenwick), (ii) such stock is listed on a national securities exchange or the
NASDAQ National Market and (iii) all Contingent Interest Notes are settled in
such common stock. Moreover, Trenwick may not settle the Contingent Interest
Notes in its common stock if the Contingent Interest Notes are being settled
following acceleration thereof due to an event of default under the Contingent
Interest Notes.
Reinsurance and Retrocessional Agreements
Trenwick enters into reinsurance and retrocessional agreements to reduce its net
liability on individual risks, protect against catastrophic losses and maintain
acceptable ratios.
Trenwick America Re has various retrocessional facilities, all of which are on a
treaty basis. These retrocessional facilities include one treaty for Trenwick
America Re's facultative casualty reinsurance business, which applies on a risk
or account basis, and two for its treaty property business, which protect it
against multiple claims arising out of a single occurrence or event. As a result
of these facilities, Trenwick America Re's maximum retention generally does not
exceed $500,000 per occurrence on facultative business and $2,300,000 per
occurrence on property catastrophe business. From 1989 to 1999, Trenwick America
Re has purchased aggregated excess of loss ratio treaties from several
reinsurers. These facilities provided Trenwick with a layer of protection
against adverse results from its domestic casualty business in excess of
specified loss ratios. Trenwick did not purchase an aggregate excess of loss
ratio treaty for 2000.
Trenwick International, as customary with companies operating in the London
market, buys large amounts of reinsurance. Reinsurance and retrocessional
coverage is customized for each class of business. During 1998, following an
increase in its share capital, Trenwick International increased its retention of
business by reducing the amount of reinsurance it buys, principally proportional
reinsurance treaties with its former parent.
Chartwell Managing Agency, as part of its business strategy, has historically
purchased a significant amount of reinsurance for the Lloyd's syndicates it
manages. Reinsurance is generally purchased to protect the syndicates against
extraordinary loss or loss involving one or more underwriting classes. The
amount purchased is determined with reference to the syndicates' aggregate
exposure and potential loss scenarios.
Canterbury Financial Group purchases reinsurance specifically tailored to each
of the specialty programs underwritten by its insurance subsidiaries.
14
<PAGE>
In connection with the acquisition of Chartwell by Trenwick, Chartwell's
insurance company subsidiaries purchased an aggregate excess of loss reinsurance
agreement providing up to $100 million in coverage against unanticipated
increases in Chartwell's reserves for business written on or before October 27,
1999, the date of completion of the acquisition of Chartwell. Within the $100
million maximum, the protection is limited to $100 million for increased
reserves attributable to Chartwell's Lloyd's operations, $25 million for
increased reserves attributable to catastrophe and year 2000 losses and $50
million for increased reserves attributable to asbestos and environmental
coverage losses. The aggregate excess of loss reinsurance agreement is not
cancelable by the reinsurers, London Life and Scandanavian Re and their
obligations have been secured by a trust account. The premium payable for this
aggregate excess of loss reinsurance agreement was approximately $56 million.
Trenwick remains liable with respect to insurance and reinsurance ceded in the
event that the insurer or retrocessionaire is unable to meet its obligations.
All reinsurers and retrocessionaires must be formally approved by the operating
company's Security Committee. The Security Committees re-evaluate the financial
condition of Trenwick reinsurers and retrocessionaires at least annually. The
evaluation process involves financial analysis of current audited financial data
and comparative analysis of such data in accordance with guidelines established
by Trenwick. Business may not be conducted with retrocessionaires who are not
currently approved by the Security Committees.
Trenwick America Re's principal retrocessionaires are Zurich Reinsurance,
Continental Casualty Company, Unum Life Insurance Company of America and
National Union Fire Insurance Company. Chartwell Re's principal
retrocessionaires are Centre Reinsurance (Bermuda) Limited, London Life and
Casualty Reinsurance Corp. and Scandinavian Reinsurance Company Limited.
INSCORP's largest reinsurers in 1999 were American Reinsurance Company,
Navigators Insurance Company and European International Reinsurance Company
Limited. Trenwick International has two principal retrocessionaires, Lloyds of
London and Transatlantic Re. All these retrocessionaires are rated A (Excellent)
or better by A.M. Best Company. At December 31, 1999, Trenwick had no material
uncollectible amounts due from its retrocessionaires.
Investments
The Investment Committee of Trenwick's Board of Directors oversees investments
and sets procedures and guidelines for investment strategy. Trenwick's internal
staff manage these investments and utilize the services of investment advisers.
Trenwick's investment strategy focuses on capital preservation and income
predictability. This strategy also requires that the risks associated with these
objectives are properly managed. Accordingly, Trenwick emphasizes investment
grade debt investments. At December 31, 1999, 79% of Trenwick's investments in
debt securities were rated Aa or better. In October 1998, certain securities had
their ratings withdrawn by various nationally recognized statistical rating
organizations. The servicer of these securities, Commercial Financial Services,
Inc., filed for protection under Chapter 11 of the Federal Bankruptcy Code in
December 1998. During 1999, Trenwick wrote down the value of these securities by
$5.2 million.
Trenwick's investment strategy permits an allocation for equity securities. At
December 31, 1999, 6% of Trenwick's total investments and cash were invested in
common and preferred equities, which consist primarily of securities issued by
U.S. and United Kingdom corporations. The primary risk associated with these
securities is the exposure to daily market fluctuations.
15
<PAGE>
The investments of each of Trenwick's insurance company subsidiaries must comply
with the respective insurance laws of the jurisdiction of domicile of that
insurance company, and of the other jurisdictions in which it is licensed or
authorized. These laws prescribe the kind, quality and concentration of
investments which may be made by insurance companies. In general, these laws
permit investments, within specified limits and subject to certain
qualifications, in federal, state and municipal obligations, corporate bonds,
preferred and common stock, real estate mortgages and real estate. These laws
generally penalize high concentrations of riskier types of assets and high
exposures to certain types of issuers.
Trenwick invests in three types of structured securities, collateralized
mortgage obligations ("CMO"), mortgage-backed securities not backed by U.S.
government agencies ("non-agency MBS") and asset-backed securities ("ABS"), each
accounting for 5%, 5% and 2%, respectively, of Trenwick's portfolio at December
31, 1999.
CMOs consist of planned amortization classes ("PACs") which have been
constructed with a certain amount of call protection and CMOs that have lost
their PAC protection (sometimes called "broken" or "busted" PACs), due to actual
prepayments being significantly higher or lower than originally forecast. These
agency backed CMOs are not subject to credit risk, as all holdings are backed
indirectly or directly by the Federal government or one of its agencies. The
material risk inherent to holding these CMOs is prepayment risk, which relates
to the timing of cash flows that result from amortization, whether it
accelerated, because of lower interest rates and therefore higher than expected
prepayments, or decelerated, because of higher interest rates and therefore
lower than expected prepayments. Changes in principal repayments could
negatively affect investment income due to the timing of the reinvested funds.
Non-agency MBSs are constructed primarily from the securitization of mortgages
on commercial or residential real estate and, lacking any agency backing, are
inherently subject to credit risk. They also have an element of prepayment risk
which is contingent on the structure of each security and its underlying
collateral. 93% of the non-agency MBS issues Trenwick has purchased have a
rating of A or better from various Nationally Recognized Statistical Rating
Organizations.
The asset-backed securities owned by Trenwick have primarily credit card and
home equity receivables as collateral and are subject also to credit risk. These
securities have less cash flow uncertainty than non-agency MBS and CMO issues,
because the issuer has the ability to add in new collateral should the
asset-backed security experience faster prepayments, or in the event of default
on the underlying collateral. 94% of the asset-backed securities owned by
Trenwick are rated A or better by various Nationally Recognized Statistical
Rating Organizations. The remaining 6% include the asset-backed securities
serviced by Commercial Financial Services, Inc. for which ratings have been
withdrawn.
Trenwick also invests in agency pass-through securities which account for 7% of
Trenwick's portfolio at December 31, 1999. As with CMOs, these securities are
subject to prepayment risk.
Trenwick holds debt securities and cash in a number of currencies. At December
31, 1999, approximately 16% of Trenwick's debt securities and cash were held in
U.K. sterling, and the remainder in six other currencies.
16
<PAGE>
The table below sets forth the distribution of Trenwick's investments available
for sale at December 31, 1999 by type, maturity and quality rating.
<TABLE>
<CAPTION>
Investments
(dollars in thousands)
Average Estimated
Maturity Fair Amortized
In Years Value Cost
<S> <C> <C> <C>
Type (debt securities)
U.S. Government bonds 4.3 $ 114,537 $ 114,839
Obligations of states and political subdivisions(1) 6.3 454,993 460,176
Mortgage-backed and asset-backed securities 8.1 288,535 290,801
Debt securities issued by British government 3.7 115,023 117,165
Debt securities issued by other foreign governments 4.9 54,996 55,436
Public utilities 14.7 20,891 21,229
Corporate securities 8.3 259,446 262,855
Certificates of deposit .2 2,940 2,937
----------- ------------
Total debt securities 6.8 $ 1,311,361 $ 1,325,438
=========== ============
Maturity (debt securities)
Due in one year or less .5 94,546 93,913
Due in one year through five 2.9 544,077 545,161
Due after five years through ten years 7.3 482,652 490,465
Due after ten years 19.1 190,086 195,899
----------- ------------
Total debt securities 6.8 $ 1,311,361 $ 1,325,438
=========== ============
Quality (debt securities)
Aaa(2)-U.S. government bonds $ 114,537 $ 114,839
Obligations of states and political subdivisions 349,474 352,936
Mortgage-backed and asset-backed securities 211,980 211,775
Debt securities issued by British government 115,023 117,165
Debt securities issued by other foreign governments 31,402 31,783
Corporate securities 14,585 14,959
Certificates of deposit 1,991 1,988
----------- ------------
838,992 845,445
----------- ------------
Aa(2)-Obligations of states and political subdivisions 77,762 78,661
Mortgage-backed and asset-backed securities 44,554 45,923
Corporate securities 58,250 58,558
Debt securities issued by other foreign governments 16,707 16,715
Public utilities 2,438 2,483
----------- ------------
199,711 202,340
----------- ------------
A(2)-Obligations of states and political subdivisions 16,006 16,232
Mortgage-backed and asset-backed securities 24,522 25,465
Debt securities issued by other foreign governments 6,887 6,938
Public utilities 13,065 13,152
Corporate securities 105,932 106,928
Certificates of deposit 809 809
----------- ------------
167,221 169,524
----------- ------------
Baa(2)-Obligations of states and political subdivisions 11,751 12,347
Mortgage-backed and asset-backed securities 5,983 6,142
Public utilities 4,335 4,469
Corporate securities 56,631 57,476
----------- ------------
78,700 80,434
----------- ------------
Ba(2)-Public utilities 1,053 1,125
Corporate securities 12,543 13,032
----------- ------------
13,596 14,157
----------- ------------
B(2)-Corporate securities 11,143 11,495
----------- ------------
Caa(2)-Corporate securities 138 183
----------- ------------
P1(2)-Certificates of deposits 140 140
----------- ------------
Non-rated Corporate security 224 224
----------- ------------
Withdrawn - Asset-backed securities 1,496 1,496
=========== ============
Total debt securities $ 1,311,361 $ 1,325,438
----------- ------------
</TABLE>
<PAGE>
(1) Obligations of states and political subdivisions include $38,240,000
escrowed in U.S. Government Securities, $242,320,000 insured by Municipal
Bond Investors Assurance Corporation, Financial Guaranty Insurance
Company, AMBAC Indemnity Corporation, or Financial Security Assurance
Corporation and $29,940,000 both escrowed and insured.
(2) Quality rating as assigned by Moody's Investors Service, Inc. for all
except certain mortgage-backed securities not backed by U.S. government
agencies and certain asset-backed securities. Quality ratings for these
other securities are as assigned by Fitch Investors Service, Standard and
Poor's or Duff and Phelps. Ratings are generally assigned upon the
issuance of the securities, subject to revision on the basis of ongoing
evaluations.
17
<PAGE>
Regulation
Trenwick and its insurance company subsidiaries are subject to regulatory
oversight under the insurance statutes and regulations of the jurisdictions in
which they conduct business, including all states of the United States and the
United Kingdom. These regulations vary from jurisdiction to jurisdiction and are
generally designed to protect ceding insurance companies and policyholders by
regulating Trenwick's financial integrity and solvency in its business
transactions and operations. Many of the insurance statutes and regulations
applicable to Trenwick's subsidiaries relate to reporting and enable regulators
to closely monitor Trenwick's performance. Typical required reports include
information concerning Trenwick's capital structure, ownership, financial
condition, and general business operations.
Trenwick International is subject to the regulatory authority of the United
Kingdom Financial Services Authority. Both Chartwell Managing Agents and
Trenwick's dedicated Lloyd's underwriting entities, as a Lloyd's managing
general agent and Lloyd's corporate members, respectively, are subject to
regulation and supervision by the Council of Lloyd's. Lloyd's operates under a
self-regulatory regime under the Lloyd's Act 1982 and has the power to set,
interpret and change the rules which govern the operation of the Lloyd's market,
subject to regulation for solvency purposes by the Financial Services Authority.
Lloyd's prescribes, in respect of its managing agents and corporate members,
certain minimum standards relating to their management and control, solvency and
various other requirements. In addition, Lloyd's imposes restrictions against
persons becoming controllers and major shareholders of managing agents and
corporate members without the consent of Lloyd's first having been obtained. The
United Kingdom government has established the Financial Services Authority as a
single regulator to supervise securities, banking and insurance business,
including Lloyd's. When the Financial Services and Market Bill becomes law,
probably in late 2000, the Financial Services Authority will have wide
authorization and intervention powers in relation to Lloyd's. A consultation
process has commenced in relation to Lloyd's regulatory framework.
NAIC
The National Association of Insurance Commissioners ("NAIC") is an organization
which assists state insurance supervisory officials in achieving insurance
regulatory objectives, including the maintenance and improvement of state
regulation. From time to time various regulatory and legislative changes have
been proposed in the insurance industry, some of which could have an effect on
reinsurers. Among the proposals that have in the past been or are at present
being considered are the possible introduction of federal regulation in addition
to, or in lieu of, the current system of state regulation of insurers, and
proposals in various state legislatures (some of which proposals have been
enacted) to conform portions of their insurance laws and regulations to various
model acts adopted by the NAIC. Trenwick is unable to predict what effect, if
any, these developments may have on its operations and financial condition. See
Item 7, Management's Discussion and Analysis of Financial Condition and Results
of Operations.
Risk Based Capital
The NAIC has adopted Risk-Based Capital ("RBC") requirements for property and
casualty insurance companies to evaluate the adequacy of statutory capital and
surplus in relation to investment and insurance risks such as asset quality,
asset and liability matching, loss reserve adequacy and other business factors.
The RBC formula is used by state insurance regulators as an early warning tool
to identify, for the purpose of initiating regulatory action, insurance
companies that potentially are inadequately capitalized. In addition, the
formula defines minimum capital standards that supplement the system of low
fixed minimum capital and surplus requirements on a state-by-state basis.
Regulatory compliance is determined by a ratio of the enterprise's regulatory
total adjusted capital to its authorized control level RBC, as defined by the
NAIC. Enterprises below specific trigger points or ratios are classified within
certain levels, each of which requires specific corrective action. The ratios of
Total Adjusted Capital to Authorized Control Level RBC for each of Trenwick's
United States insurance company subsidiaries exceeded all the RBC trigger points
at December 31, 1999, 1998 and 1997.
18
<PAGE>
State Insurance Regulation
The premium rates and policy terms of Trenwick's reinsurance agreements
generally are not subject to regulation by any government authority. This
contrasts with Trenwick's property and casualty insurance operations where the
premium rates and policy terms are generally closely regulated by state
insurance departments. As a practical matter, however, the premium rates charged
by insurers may place a limit on the rates which can be charged by reinsurers.
The regulation and supervision to which Trenwick's insurance subsidiaries are
subject relate primarily to the standards of solvency that must be met and
maintained, licensing requirements for reinsurers, the nature of and limitations
on investments, restrictions on the size of risks which may be insured, deposits
of securities for the benefit of insureds or reinsureds, methods of accounting,
periodic examinations of the financial condition and affairs of reinsurers, the
form and content of reports of financial condition required to be filed, and
reserves for unearned premiums, losses and other purposes. In general, such
regulation is for the protection of the insureds and reinsureds, rather than
Trenwick's security holders. Trenwick believes that it is in compliance with all
such material regulations.
Trenwick is subject to regulation under the insurance statutes and insurance
holding company statutes of various states, including Connecticut, New York and
North Dakota, the domicile states of its U.S. insurance companies. These laws
and regulations vary from state to state, but generally require an insurance
holding company, and insurers and reinsurers that are subsidiaries of an
insurance holding company, to register with the state regulatory authorities and
to file with those authorities certain reports including information concerning
their capital structure, ownership, financial condition and general business
operations.
State laws also require prior notice or regulatory agency approval of direct or
indirect changes in control of an insurer, reinsurer or its holding company and
of certain significant intercorporate transfers of assets within the holding
company structure. An investor who acquires securities representing or
convertible into more than 10% of the voting power of the securities of Trenwick
would become subject to at least some of such regulations and would be subject
to approval by the Connecticut, New York and North Dakota Insurance
Commissioners prior to acquiring such shares. Such investor would also be
required to file certain notices and reports with the Insurance Commissioners
prior to such acquisition.
Codification of Statutory Accounting Principles
In March 1998, the NAIC adopted the Codification of Statutory Accounting
Principles ("Codification"). The Codification, which is intended to standardize
regulatory accounting and reporting for the insurance industry, is proposed to
be January 1, 2001. The Codification provides guidance for areas where statutory
accounting has been silent and changes current statutory accounting in some
areas. However, statutory accounting principles will continue to be established
by individual state laws and permitted practices. Effective January 1, 2001, the
states of Connecticut (domicile of Trenwick America Re), Minnesota (domicile of
Chartwell Reinsurance), New York (domicile of INSCORP and ReCor) and North
Dakota (domicile of Dakota) will adopt the Codification. It is uncertain what
effect adoption of the Codification for the preparation of statutory financial
statements would have on those statutory financial statements.
19
<PAGE>
Dividends
Because Trenwick's operations are conducted through its operating subsidiaries,
Trenwick is dependent upon the ability of its operating subsidiaries, to
transfer funds, principally in the form of cash dividends, tax reimbursements
and other statutorily permissible payments. In addition to general legal
restrictions on payments of dividends and other distributions to shareholders
applicable to all corporations, Trenwick's insurance subsidiaries are subject to
further regulations that, among other things, restrict the amount of dividends
and other distributions that may be paid to their parent corporations.
Under the applicable provisions of the insurance holding company laws of the
states of domicile of Trenwick America Re, Chartwell Reinsurance and Dakota,
such companies may only pay dividends without the approval of the applicable
state insurance regulator, if such dividends, together with other dividends paid
within the preceding twelve months, are less than the greater of (i) 10% of the
insurer's policyholders' surplus as of the end of the prior calendar year or
(ii) the insurer's statutory net income, excluding realized capital gains, for
the prior calendar year. As a further restriction, the maximum amount of
dividends most U.S. insurers may pay is limited to its earned surplus, also
known as its unassigned funds. Any dividend in excess of the amount determined
pursuant to the foregoing formula would be characterized as an "extraordinary
dividend" requiring the prior approval of the state insurance regulator.
Under New York law, which is applicable to INSCORP and ReCor Insurance Company
Inc. ("ReCor") the maximum ordinary dividend payable in any twelve month period
without the approval of the New York Insurance Department is the lesser of (i)
10% of policyholders surplus as shown on the company's last annual statement or
any more recent quarterly statement or (ii) the company's adjusted net
investment income. Adjusted net investment income is defined as net investment
income for the twelve months preceding the declaration of the dividend plus the
excess, if any, of net investment income over dividends declared or distributed
during the period commencing thirty-six months prior to the declaration or
distribution of the current dividend and ending twelve months prior thereto. In
any case, New York law permits the payment of an ordinary dividend by an insurer
or reinsurer only out of earned surplus.
In addition to the foregoing limitations, the New York Insurance Department, as
is its practice in any change of control situation, required Trenwick to commit
to preclude the acquired New York-domiciled insurers, INSCORP and ReCor, from
paying any dividends for two years after the merger with Chartwell without prior
regulatory approval. The foregoing restriction will expire on October 27, 2001.
Neither INSCORP nor ReCor paid any dividends in 1997, 1998 or 1999.
Moreover, insurance holding company laws generally provide that, notwithstanding
the receipt of any dividend from a subsidiary insurer, an insurer may make
dividend payments to its parent only to the extent it is permitted to do so
under its applicable dividend restrictions. In other words, the ability of a
subsidiary insurer to pay dividends without restriction may be impaired if its
parent insurer cannot pay dividends without restriction.
The maximum dividend permitted by law may not be indicative of an insurer's
actual ability to pay dividends, which may be constrained by business and other
regulatory considerations, such as the impact of dividends on surplus, which
could affect an insurer's ratings or competitive position, the amount of
premiums that can be written and the ability to pay future dividends.
Furthermore, beyond the limits described in the preceding paragraph, insurance
regulatory authorities often have the discretion to limit the payment of
dividends by insurance companies domiciled in their jurisdictions.
20
<PAGE>
In 2000, of Trenwick's U.S. insurance subsidiaries, only Dakota could pay a
dividend or other distribution without prior approval of the applicable
insurance regulatory authority. In 2000, Dakota Specialty could pay a dividend
of $2.8 million without prior approval. During 1999, 1998 and 1997, Trenwick
America Re paid dividends of $53.4 million, $30.1 million and $8.3 million,
respectively. Chartwell Reinsurance paid dividends of $30.3 million in 1999 and
$3.0 million in 1997. Chartwell Reinsurance did not pay any dividends in 1998.
None of Trenwick's other U.S. insurance subsidiaries paid any dividends in 1999,
1998 or 1997.
Under the applicable laws of the United Kingdom, Trenwick's U.K. subsidiaries
may make shareholder distributions only from accumulated realized profits, net
of accumulated realized losses. In addition, under the U.K. Insurance Companies
Act, Trenwick International is not permitted to make any distribution that would
reduce its net assets below the required minimum margin of solvency which, as
determined under the U.K. Financial Service Authority's rules, is approximately
$16.7 million as of December 31, 1999. Trenwick International must also notify
the United Kingdom Financial Services Authority of any proposal to declare or
pay a dividend on any of its share capital. Under Lloyd's regulations, Chartwell
Managing Agents is not permitted to make any distribution that would cause its
assets to fall below any of Chartwell Managing Agents' share capital, minimum
net current asset margin or minimum net asset margin. As of December 31, 1999,
the highest of the three tests required Chartwell Managing Agents to maintain
approximately $1.1 million of capital.
Investment Limitations
Connecticut, New York and North Dakota laws and regulations govern the types and
amounts of investments which are permissible for Trenwick's insurance company
subsidiaries. These rules are designated to ensure the safety and liquidity of
the insurers' investment portfolio. In general, these rules permit insurers to
purchase only investments which are interest bearing, interest accruing,
entitled to dividends or otherwise income earning and not then in default in any
respect, and insurers must be entitled to receive for its exclusive account and
benefit the interest or income accruing thereon. No security or investment is
eligible for purchase at a price above its fair value or market value. In
addition, these rules require investments by Trenwick to be diversified. The
U.K. Financial Services Authority governs the types and amounts of investments
which are permissible for insurers in the United Kingdom, including Trenwick
International. Likewise, Lloyd's regulations govern the types and amounts of
investments that are permissible for Chartwell Managing Agents to make with the
assets of the Lloyd's syndicates that it manages. These laws penalize high
concentrations of riskier types of assets and high exposures to certain types of
issuers. Trenwick believes that it is in compliance with all material applicable
investment laws.
Employees
At December 31, 1999, Trenwick employed a total of 124 and 284 persons in its
domestic and international operations, respectively. Trenwick has no employees
represented by a labor union and believes that its employee relations are good.
21
<PAGE>
TRENWICK GROUP INC. AND SUBSIDIARIES
SCHEDULE II-CONDENSED FINANCIAL INFORMATION OF REGISTRANT
TRENWICK GROUP INC.
BALANCE SHEET
(Parent Company Only)
December 31,
----------------------------
1999 1998
------------ -----------
(in thousands)
Assets:
Investments in consolidated subsidiaries $ 558,151 $ 532,069
Cash and cash equivalents 2,331 523
Due from consolidated subsidiaries 57,526 4,287
Deferred debt issuance costs 6,388 2,463
Accrued investment income 128 125
Net deferred income taxes 15,000 4,198
Goodwill 153,824 1,605
Other assets 9,421 9
------------ -----------
Total assets $ 802,769 $ 545,279
============ ===========
Liabilities:
6.70% Senior notes due 2003 $ 75,000 $ 75,000
Junior subordinated debentures 113,403 113,403
Contingent interest notes 34,699 -
Due to consolidated subsidiaries 10,965 2,700
Accrued interest expense 5,497 5,424
Chase syndicated senior credit facilities 94,501 -
Other liabilities 6,455 723
------------ -----------
Total liabilities 340,520 197,250
Stockholders' equity 462,249 348,029
------------ -----------
Total liabilities and stockholders' equity $ 802,769 $ 545,279
============ ===========
S-1
<PAGE>
TRENWICK GROUP INC. AND SUBSIDIARIES
SCHEDULE II--CONDENSED FINANCIAL INFORMATION OF REGISTRANT-(continued)
TRENWICK GROUP INC.
STATEMENT OF INCOME
(Parent Company Only)
Year ended December 31,
---------------------------------------
1999 1998 1997
----------- ------------ ----------
(in thousands)
Revenues:
Consolidated subsidiary dividends $ 46,100 $ 26,600 $ 8,250
Net investment income 358 1,500 4,974
Net realized investment gains - 778 -
Other income 1 12 -
----------- ------------ ----------
Total revenues 46,459 28,890 13,224
Interest and operating expenses 16,938 13,950 10,090
Amortization expense 1,423 33 -
Income before income taxes, equity in
undistributed income of unconsolidated
subsidiaries and extraordinary item 28,098 14,907 3,134
Income tax benefit (5,077) (3,942) (1,239)
----------- ------------ ----------
Income before equity in undistributed
income of consolidated subsidiaries 33,175 18,849 4,373
Equity in undistributed income (loss)
of consolidated subsidiaries (44,223) 15,943 31,916
----------- ------------ ----------
Income (loss) before extraordinary
loss on debt redemption (11,048) 34,792 36,289
Extraordinary loss on debt redemption,
net of $558 income tax benefit - - 1,037
----------- ------------ ----------
Net income (loss) $ (11,048) $ 34,792 $ 35,252
=========== ============ ==========
S-2
<PAGE>
TRENWICK GROUP INC. AND SUBSIDIARIES
SCHEDULE II--CONDENSED FINANCIAL INFORMATION OF REGISTRANT-(continued)
TRENWICK GROUP INC.
STATEMENT OF CASH FLOWS
(Parent Company Only)
<TABLE>
<CAPTION>
Year ended December 31,
-----------------------------------------------
1999 1998 1997
---------------- ------------ ------------
(in thousands)
<S> <C> <C> <C>
Cash flows from operating activities:
Dividends and net investment income received $ 46,466 $ 28,548 $ 12,642
Interest and operating expenses paid (14,979) (11,786) (4,983)
Income taxes received 3,669 5,035 794
---------------- ------------ ------------
Cash provided by operating activities 35,156 21,797 8,453
---------------- ------------ ------------
Cash flows for investing activities:
Purchases of debt securities - (16,637) (72,932)
Sales of debt securities - 88,190 -
Maturities of debt securities - 911 16,050
Investment in subsidiaries (8,282) (130,582) (3,403)
---------------- ------------ ------------
Cash used for investing activities (8,282) (58,118) (60,285)
---------------- ------------ ------------
Cash flows from financing activities:
Issuance of senior notes - 75,000 -
Issuance of junior subordinated debentures - - 113,403
Issuance costs of senior notes and capital securities (4,055) (922) (1,669)
Long term debt proceeds 94,473 - -
Redemption of convertible debentures - - (46,997)
Issuance of common stock - 1,536 956
Repurchase of common stock (44,604) (34,880) (171)
Dividends paid (12,787) (11,698) (11,546)
Intercompany loans (58,093) 2,700 -
---------------- ----------- ------------
Cash provided by financing activities (25,066) 31,736 53,976
---------------- ----------- ------------
Change in cash and cash equivalents 1,808 (4,585) 2,144
Cash and cash equivalents, beginning of year 523 5,108 2,964
---------------- ----------- ------------
Cash and cash equivalents, end of year $ 2,331 $ 523 $ 5,108
================ =========== ============
</TABLE>
S-3
<PAGE>
TRENWICK GROUP INC. AND SUBSIDIARIES
SCHEDULE III -- SUPPLEMENTARY INSURANCE INFORMATION
(in thousands)
<TABLE>
<CAPTION>
1999 1998 1997
----------- ---------- ---------
<S> <C> <C> <C> <C>
Deferred policy acquisition costs Trenwick America Re $34,757 $21,023 $22,524
Canterbury Financial Group 3,215 - -
Trenwick International 19,982 14,238 -
Chartwell Managing Agents 20,942 - -
----------- ---------- ---------
78,896 35,261 22,524
Unpaid claims and claim expenses Trenwick America Re 1,201,954 546,292 518,387
Canterbury Financial Group 142,215 - -
Trenwick International 164,264 136,136 -
Chartwell Managing Agents 455,706 - -
----------- ---------- ---------
1,964,139 682,428 518,387
Unearned premium income Trenwick America Re 110,909 75,206 87,020
Canterbury Financial Group 63,133 - -
Trenwick International 100,336 76,845 -
Chartwell Managing Agents 105,306 - -
----------- ---------- ---------
379,684 152,051 87,020
Net premiums earned Trenwick America Re 166,906 174,443 190,156
Canterbury Financial Group 10,343 - -
Trenwick International 107,911 71,118 -
Chartwell Managing Agents 39,954 - -
----------- ---------- ---------
325,114 245,561 190,156
Net Investment Income Trenwick America Re 49,315 44,490 43,692
Canterbury Financial Group 1,722 - -
Trenwick International 11,253 10,614 -
Chartwell Managing Agents 3,845 - -
Unallocated 259 1,212 4,710
----------- ---------- ---------
66,394 56,316 48,402
Claims and claims expenses incurred Trenwick America Re 130,603 105,478 109,554
Canterbury Financial Group 5,766 - -
Trenwick International 80,866 47,657 -
Chartwell Managing Agents 37,303 - -
----------- ---------- ---------
254,538 153,135 109,554
Policy acquisition costs Trenwick America Re 61,633 58,310 58,549
Canterbury Financial Group 916 - -
Trenwick International 22,627 15,887 -
Chartwell Managing Agents 10,919 - -
----------- ---------- ---------
96,095 74,197 58,549
Underwriting expenses Trenwick America Re 13,790 13,789 15,425
Canterbury Financial Group 2,687 - -
Trenwick International 15,364 10,006 -
Chartwell Managing Agents 5,548 - -
----------- ---------- ---------
37,389 23,795 15,425
Net premiums written Trenwick America Re 155,108 169,112 195,230
Canterbury Financial Group 5,641 - -
Trenwick International 129,399 81,107 -
Chartwell Managing Agents 64,462 - -
----------- ---------- ---------
354,610 250,219 195,230
</TABLE>
S-4
<PAGE>
TRENWICK GROUP INC. AND SUBSIDIARIES
SCHEDULE V - VALUATION AND QUALIFYING ACCOUNTS
PERIOD FROM OCTOBER 28, 1999 TO DECEMBER 31, 1999
(in thousands)
Balance at Charged to Balance at
Beginning Costs and End of
of Period Expenses Period
----------- ----------- -----------
Period Ended December 31, 1999
Reinsurance recoverable:
Allowance for Uncollectible
Reinsurance (1)....................$ 6,402 $ 167 $ 6,569
Year Ended December 31, 1998
Reinsurance recoverable:
Allowance for Uncollectible
Reinsurance (1)....................$ 6,394 $ 8 $ 6,402
Year Ended December 31, 1997
Reinsurance recoverable:
Allowance for Uncollectible
Reinsurance (1)....................$ 5,731 $ 663 $ 6,394
(1) Trenwick has a reinsurance agreement which protects Trenwick from
certain uncollectible reinsurance balances. Uncollectible amounts
have been ceded to said contract and are reflected as reinsurance
recoverable in the balance sheet. Deductions to reserve represent
subsequent collections of amounts deemed uncollectible.
S-5
<PAGE>
Report of Independent Accountants on
Financial Statement Schedules
To the Board of Directors of
Trenwick Group Inc.
Our audits of the consolidated financial statements referred to in our report
dated February 29, 2000, except as to Note 19, which is as of March 1, 2000,
appearing in the 1999 Annual Report to Stockholders of Trenwick Group Inc.
(which report and consolidated financial statements are incorporated by
reference in this Annual Report on Form 10-K) also included an audit of the
financial statement schedules listed in this Annual Report on Form 10-K. In our
opinion, these financial statement schedules present fairly, in all material
respects, the information set forth therein when read in conjunction with the
related consolidated financial statements.
PricewaterhouseCoopers LLP
New York, New York
February 29, 2000
S-6
<PAGE>
EXHIBIT 13.1
AMENDED EXCERPTS FROM TRENWICK'S 1999 ANNUAL REPORT TO STOCKHOLDERS
EXPRESSLY INCORPORATED BY REFERENCE IN THIS FORM 10-K
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Industry Overview
The trends experienced by the property and casualty insurance and reinsurance
industry during the past five years continued in 1999. The industry's
underwriting margins continued to experience pressure due to highly competitive
conditions. While the number of industry participants declined further,
principally because of industry consolidation, the remaining insurance and
reinsurance industry participants are larger and better capitalized. Insurers'
and reinsurers' investment portfolios, which consist principally of fixed income
securities, continued to underperform primarily due to low interest rates
experienced in recent years. Operating cash flow declined as a result of lower
underwriting margins and continued deterioration in prior years' claim reserves.
There have recently been indications of increases in insurance and reinsurance
rates primarily associated with international property business; however, at
this time the increases reported are isolated and sporadic, and as such, no
significant improvement in general market conditions is expected in the near
term.
Several years ago, in response to ongoing industry conditions, Trenwick embarked
on a strategy of increasing its size and the diversity of its insurance and
reinsurance businesses in order to compete more effectively in the insurance and
reinsurance marketplace.
On October 27, 1999, Trenwick, upon its merger with Chartwell Re Corporation,
became the second-largest independent reinsurer in the United States on the
basis of surplus. The acquisition of Chartwell provided Trenwick with additional
cost-effective means of augmenting capital, accelerating premium growth and
added structural platforms for further expansion. The addition of Chartwell's
U.S. reinsurance business, its admitted and non-admitted U.S. insurance
companies and its operations at Lloyd's continued Trenwick's strategy of
entering new markets and product lines that began with Trenwick's acquisition of
Trenwick International (formerly SOREMA (UK) Limited) in 1998. Trenwick
International, a London market company, underwrites specialty insurance and
treaty and facultative reinsurance on a worldwide basis. Trenwick expects that
the merger with Chartwell will produce between $15 million and $25 million in
annual expense synergies in 2000 and 2001, respectively.
Trenwick's plan to diversify and broaden its markets continued with the December
19, 1999 announcement by Trenwick and LaSalle Re Holdings Limited of a
definitive agreement to combine the two companies, with shareholders of both
companies receiving shares in a new Bermuda holding company to be named Trenwick
Group Ltd. This transaction will create a new Bermuda-based global insurance and
reinsurance underwriting organization with an anticipated total capitalization
of approximately $1.1 billion. The new Trenwick is expected to have larger scale
and stronger competitive capabilities in a consolidating global
insurance/reinsurance market, add higher margin business to Trenwick's existing
mix, establish a stronger platform to enhance shareholder returns and expand
Trenwick's management depth. Trenwick anticipates that the combined enterprise
will have a strong presence in the three most significant insurance markets in
the world: the United States, London and Bermuda.
1
<PAGE>
On a pro forma basis, Trenwick would have had assets of approximately $4.0
billion and shareholders' equity, including minority interest, of approximately
$800 million as of December 31, 1999 and combined 1999 gross written premiums
for Trenwick, Chartwell and LaSalle of approximately $1.0 billion.
Premium
Trenwick's gross and net premium writings for its domestic and international
operations were as follows:
1999 1998 1997
----------- ----------- ----------
Gross Premiums Written
Trenwick America Re $210,921(1) $218,249 $248,662
Trenwick International 171,698 105,114(2) -
Chartwell Managing Agents 84,834(3) - -
Canterbury Financial 38,088(4) - -
Total $505,541 $323,363 $248,662
Net Premiums Written
Trenwick America Re $155,108(1) $169,112 $195,230
Trenwick International 129,399 81,107(2) -
Chartwell Managing Agents 64,462(3) - -
Canterbury Financial 5,641(4) - -
Total $354,610 $250,219 $195,230
(1) Includes reinsurance business of Chartwell Reinsurance and its subsidiaries
since its acquisition on October 27, 1999.
(2) Includes Trenwick International business since its acquisition on February
27, 1998.
(3) Includes Chartwell Managing Agents business since its acquisition on October
27, 1999.
(4) Includes Canterbury Financial business since its acquisition on October 27,
1999.
In 1999, Trenwick reported net premiums written of $354.6 million, a 42%
increase compared to $250.2 million in 1998. Net premiums written in 1998
increased 28% compared to 1997. Trenwick's domestic net reinsurance premiums
written decreased 8% in 1999 over 1998 compared to a 13% decrease in 1998 over
1997.
The decline in Trenwick's domestic reinsurance premium volume in 1999 and 1998
is primarily attributable to a decline in net casualty premium writings of 2%.
This decline reflects Trenwick America Re's withdrawal from accounts when
pricing fell below what it believed to be acceptable rate levels. The decline in
net premiums written was magnified by Trenwick's decision to buy increased
reinsurance protection in 1999, 1998 and 1997 at more favorable terms than in
prior years. Competition among primary companies also caused cedants to reduce
their own premium writings or restructure their reinsurance programs, reducing
the amount of reinsurance they purchase. As a result of consolidation within the
industry, many ceding companies are now larger and financially stronger,
enabling them to retain more risk.
2
<PAGE>
Trenwick International reported net premiums written of $129.4 million for the
year ended December 31, 1999 compared to net premiums written of $81.1 million
for the post-acquisition period ended December 31, 1998. Trenwick
International's net premium writings for the full year 1998 were $100.8 million.
While the international business is also highly competitive, growth in this
business has occurred as a result of emerging pockets of opportunity and as a
result of Trenwick International's expansion into new geographic markets
previously limited by its former parent.
During the period from October 28, 1999 to December 31, 1999, Chartwell Managing
Agents' syndicates reported net premiums written of $64.5 million. Including the
period prior to Chartwell Managing Agents' acquisition by Trenwick, Chartwell
Managing Agents' syndicates reported net premiums written of $190.4 million for
the year ended December 31, 1999 compared to net premiums written of $64.9
million for the prior year. Prior to its acquisition by Trenwick, Chartwell had
increased significantly the amount of capacity it supplied to the syndicates
managed by Chartwell Managing Agents, resulting in the aforementioned increase
in premium writings. During 1999, Trenwick supplied 45.8% of the overall
syndicate capacity for Chartwell Managing Agents.
From October 28, 1999 to December 31, 1999, Canterbury Financial reported net
premiums written of $5.6 million. For the year ended December 31, 1999, which
includes the period before Canterbury Financial was acquired by Trenwick,
Canterbury Financial reported net premiums of $43.8 million, a 7% decrease over
the year ended December 31, 1998. The decrease in net premium writings resulted
principally from changes in certain reinsurance programs, increasing the amount
of reinsurance purchased in 1999.
Operating Ratios
The following table sets forth Trenwick's combined ratios and its components
calculated on a GAAP basis for the periods indicated:
<TABLE>
<CAPTION>
Claims and Policy
Claims Acquisition Underwriting Total Combined
Expense Ratio Expense Ratio Expense Ratio Expense Ratio Ratio
-------------- ---------------- ----------------- -------------- ----------
1999
<S> <C> <C> <C> <C> <C>
Trenwick America Re(1) 78.3% 36.9% 8.3% 45.2% 123.5%
Trenwick International 74.9% 21.0% 14.2% 35.2% 110.1%
Canterbury Financial(2) 55.7% 8.9% 26.0% 34.9% 90.6%
Chartwell Managing Agents(3) 93.4% 27.3% 13.9% 41.2% 134.6%
Trenwick Group 78.3% 29.6% 11.5% 41.1% 119.4%
1998
Trenwick America Re 60.5% 33.4% 7.9% 41.3% 101.8%
Trenwick International 67.0% 22.3% 14.1% 36.4% 103.4%
Trenwick Group 62.4% 30.2% 9.7% 39.9% 102.3%
1997
Trenwick America Re 57.6% 30.8% 8.1% 38.9% 96.5%
Trenwick Group 57.6% 30.8% 8.1% 38.9% 96.5%
</TABLE>
----------------------------------------
(1) Includes reinsurance business of Chartwell Reinsurance and its subsidiaries
since its acquisition on October 27, 1999
(2) Includes Canterbury Financial business since its acquisition on October 27,
1999
(3) Includes Chartwell Managing Agents business since its acquisition on October
27, 1999
The combined ratio is one means of measuring the profitability of a property and
casualty insurance or reinsurance company. The combined ratio reflects
underwriting experience, but does not reflect income from investments or
provisions for income taxes. A combined ratio below 100% indicates profitable
underwriting, and a combined ratio exceeding 100% indicates unprofitable
underwriting. Although an insurer or reinsurer may have unprofitable
underwriting results, the reinsurer may still be profitable because of
investment income earned on its accumulated invested assets.
3
<PAGE>
The most significant underwriting cost affecting an insurance or reinsurance
company's underwriting result is represented by its claims and claims expense
ratio, which is the ratio of incurred claims and claims adjustment expenses to
net earned premiums. The claims and claims expense ratio is a function of
estimates of claims associated with business written in the current period and
changes in estimates of claims on business written in prior periods.
Trenwick's claims and claims expense ratio increased from 62.4% in 1998 to 78.3%
in 1999. Trenwick's claims and claims expense ratio deteriorated in 1999 due to
the effects of property catastrophe claims of approximately $12.9 million and
adverse development of prior year reserves for claims and claims expense of
approximately $14.6 million. At December 31, 1999, losses ceded to the Company's
adverse development cover amounted to $46.5 million. Excluding the benefit of
the adverse development cover, the claims and claims expense ratio in 1999 would
have been 92.6%.
Trenwick America Re's claims and claims expense ratio was 78.3% in 1999 compared
to 60.5% in 1998 and 57.6% in 1997. The increase in Trenwick America Re's claims
and claims expense ratio in 1999 is primarily due to the reasons described in
the paragraph above.
Trenwick International's claims and claims expense ratio was 74.9% in 1999
compared to 67.0% in 1998. The increase was due primarily to catastrophe losses
associated with the European winter storms that occurred in the fourth quarter
of 1999.
Trenwick's expense ratio, which is the ratio of policy acquisition costs and
underwriting expenses to net earned premiums as determined in accordance with
GAAP, increased in 1999 to 41.1% compared to 39.9% in 1998 and 38.9% in 1997. As
was the case in 1998, the overall increase in the expense ratio reflected the
continued increase in costs associated with Trenwick America Re. During 1999 and
1998, insurance companies continued to increase commissions on business ceded to
reinsurers. The increase associated with domestic reinsurance business was
partially offset by a reduction in Trenwick International's expense ratio and
the inclusion of Canterbury Financial and Chartwell Managing Agents in the
fourth quarter of 1999 whose underwriting results, in aggregate, carry a lower
expense ratio. Trenwick's domestic reinsurance expense ratio in 1999 was 45.2%
compared to 41.3% in 1998 and 38.9% in 1997. Trenwick International's expense
ratio was 35.2% in 1999 compared to 36.4% in 1998.
4
<PAGE>
Trenwick America Re's statutory combined ratios for 1999, 1998 and 1997 were
165.5%, 102.3% and 95.9% respectively. Trenwick America Re's 1999 statutory
combined ratio includes the results of Chartwell Reinsurance Company, both
before and after its acquisition by Trenwick. Trenwick America Re's statutory
combined ratios were 50.9 percentage points worse, 2.2 percentage points better
and 6.8 percentage points better, respectively, than the weighted average
statutory combined ratios for all reinsurance companies which reported their
results to the Reinsurance Association of America ("RAA") in those periods. The
statutory combined ratios for this group of reinsurance companies in 1999, 1998
and 1997 were 114.6%, 104.5% and 102.7%, respectively. The statutory combined
ratios as reported to the RAA by those companies, including Trenwick America Re,
which primarily accept business from brokers, for 1999, 1998 and 1997 were
112.3%, 106.2% 104.6%, respectively.
Consolidated Results of Operations
Year Ended December 31, 1999 Compared With Year Ended December 31, 1998
Revenues
Total revenues for the year ended December 31, 1999 increased 26.7% to $394.3
million, compared to $311.3 million for the comparable period in 1998. Included
in Trenwick's consolidated results of operations for 1999 are Chartwell's
operating results since its merger with Trenwick on October 27, 1999.
Net Premiums Earned
Net premiums earned for the year ended December 31, 1999 were $325.1 million,
compared to $245.6 million in 1998, a 32.4% increase compared to the same period
in 1998. This increase reflects the inclusion of Chartwell's business since its
acquisition on October 27, 1999 and an increase in business underwritten by
Trenwick International, offset in part by a decline in business underwritten by
Trenwick America Re.
Net Investment Income
Trenwick's net investment income was $66.4 million in 1999 compared to $56.3
million in 1998. The overall increase in investment income in 1999 is due to the
continued growth in Trenwick's invested asset base resulting primarily from the
acquisition of Chartwell's business, offset by decreases resulting from funding
requirements for the repurchase of Trenwick's common stock, reduced business
written by Trenwick America Re and lower interest rates on the reinvestment of
securities at maturity. Pre-tax yields on Trenwick's invested assets, excluding
equity securities, were 6.2% in 1999 compared to 6.4% in 1998. This decline in
1999 resulted primarily from the reinvestment of approximately $397.2 million of
maturing securities at lower yields. In 1999, maturing securities included $24.6
million of principal repayments associated with Trenwick's portfolio of
mortgage-backed and asset-backed securities, compared to $32.0 million in 1998.
Principal repayments decreased in 1999 due to the increase in interest rates
from 1998.
Net Realized Investment Gains
Trenwick realized net investment gains of $1.9 million or $.16 per basic and
diluted share for 1999 compared to $9.0 million or $.77 per basic and diluted
share for the same period in 1998. Included in 1999 net realized investment
gains were $5.2 million of losses related to the write-down to net realizable
value of certain debt securities in Trenwick's portfolio.
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Other Income and Equity Earnings of Investees
For the years ended December 31, 1999 and 1998, other income was $.7 million and
$.4 million, respectively, which consisted of foreign transaction gains. Equity
earnings of investees was $.2 million in 1999.
Claims and Claims Expenses Incurred
Trenwick's principal expense, claims and claims expenses incurred, was $254.5
million for the year ended December 31, 1999, a 66.2% increase compared to
$153.1 million for the comparable period in 1998. The increase is principally
attributable to an increase in premium volume following the inclusion of
Chartwell's business since its acquisition on October 27, 1999. Claims and
claims expenses associated with Chartwell's business amounted to $42.7 million.
In addition, claims and claims expense increased as a result of increases in
estimates of prior accident year claims of $14.6 million in 1999 and claims
arising from catastrophe losses in 1999 of $12.9 million.
Policy Acquisition Costs
Policy acquisition costs, which vary directly with premium volume and consist
primarily of commissions paid to ceding companies and agents and brokerage fees
paid to intermediaries, less commissions received on business ceded to other
reinsurers, were $96.1 million for the year ended December 31, 1999, compared to
$74.2 million for the same period in 1998. Policy acquisition costs expressed as
a percentage of net earned premiums (the acquisition expense ratio) decreased
slightly to 29.6% in 1999 from 30.2% in 1998.
Underwriting Expenses
In 1999, Trenwick recorded underwriting expenses of $37.4 million compared to
$23.8 million in 1998. The reason for the increase in underwriting expenses was
due to the inclusion of Chartwell's business since its acquisition on October
27, 1999 and certain non-recurring expenses, including severance costs
associated with the acquisition of Chartwell. As a result, Trenwick recorded an
underwriting loss, which is net earned premiums less claims and claims expenses
incurred, policy acquisition costs and underwriting expenses, of $62.9 million
in 1999 compared to an underwriting loss of $5.6 million in 1998.
Other Expenses
Other expenses, which include amortization of goodwill and other intangibles,
general and administrative expenses, interest expense and minority interest in
subsidiary trust were $27.5 million for the year ended December 31, 1999
compared to $17.2 million for the same period in 1998. The increase reflects the
addition of goodwill and increases in general and administrative expenses and
interest expense in conjunction with the acquisition of Chartwell.
Income Before Income Taxes
Trenwick incurred a net loss before income taxes of $21.2 million for the year
ended December 31, 1999 compared to net income of $43.0 million for the same
period in 1998. The net loss occurred for the reasons described above.
Income Taxes
The income tax benefit for the year ended December 31, 1999 was $10.2 million
compared with a provision for income taxes of $8.2 million for the same period
in 1998. The effective tax rate was 48% and 19% for the years ended December 31,
1999 and 1998, respectively. The main reason for the increase in Trenwick's
effective tax rate above the statutory rate of 35% in 1999 was the loss
experienced by Trenwick in 1999, which limited the benefits recognizable on
investments in tax-exempt securities. The principal factor in the decline below
the statutory rate of 35% for 1998 results from the benefit recognized on
investments in tax-exempt securities.
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As of December 31, 1999, Trenwick has U.S. net operating loss carryforwards of
$53.2 million available to offset future regular taxable income until 2019. Of
the total net operating loss carryforward, $15.7 million was generated by The
Insurance Corporation of New York (INSCORP) prior to its acquisition by
Chartwell in 1995 and is limited by Section 382 of the Internal Revenue Code to
an annual amount of $3.5 million to offset future taxable income each year.
During 1999, Trenwick recorded a valuation allowance of $24.0 million to reduce
its deferred tax asset. The valuation allowance is necessary because sufficient
uncertainty exists regarding the realizability of certain foreign tax credits
and other deferred tax assets related to the excess tax basis of foreign
subsidiaries. Any reduction in the valuation allowance will be offset against
goodwill.
Net Income
Trenwick incurred a net loss of $11.0 million for the year ended December 31,
1999 compared with a net profit of $34.8 million for the comparable 1998 period.
The basic loss per share was $.94 for the year ended December 31, 1999 as
compared to basic net income of $2.99 per share for the same period in 1998. The
diluted loss per share was $.94 per share compared to diluted net income of
$2.95 per share for the year ended December 31, 1998.
Year Ended December 31, 1998 Compared With Year Ended December 31, 1997
Revenues
Total revenues for the year ended December 31, 1998 increased 29.2% to $311.3
million, compared to $240.9 million for the comparable period in 1997. Included
in Trenwick's consolidated results of operations for 1998 are Trenwick
International's operating results since its acquisition on February 27, 1998.
Net Premiums Earned
Net premiums earned for the year ended December 31, 1998 were $245.6 million,
compared to $190.2 million in 1997, a 29.1% increase compared to the same period
in 1997. This increase reflects the inclusion of Trenwick International's
business since its acquisition on February 27, 1998.
Net Investment Income
Trenwick's net investment income was $56.3 million in 1998 compared to $48.4
million in 1997. The overall increase in investment income in 1998 was due to
the continued growth in Trenwick's invested asset base resulting primarily from
the acquisition of Trenwick International offset in part by the decrease in
Trenwick America Re's invested asset base resulting from sales of approximately
$88.1 million of securities to fund the acquisition of Trenwick International
and the repurchase of Trenwick's common stock. Trenwick's pre-tax yield on
invested assets, excluding equity securities, was 6.4% in 1998, unchanged from
1997.
Net Realized Investment Gains
Trenwick realized net investment gains of $9.0 million or $.77 per basic and
diluted share for 1998 compared to $2.3 million or $.20 per basic share and $.19
per diluted share for the same period in 1997.
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Other Income
Other income was $.4 million for the year ended December 31, 1998 compared to
$.01 million for the same period in 1997. This increase was due to the inclusion
of Trenwick International's foreign transaction gains and losses.
Claims and Claims Expenses Incurred
Trenwick's principal expense, claims and claims expenses incurred was $153.1
million for the year ended December 31, 1998, a 39.7% increase compared to
$109.6 million for the comparable period in 1997. The increase was principally
attributable to the increase in premiums written by Trenwick due to the
inclusion of Trenwick International's underwriting results since its acquisition
on February 27, 1998.
Policy Acquisition Costs
Policy acquisition costs, which vary directly with premium volume and consist
primarily of commissions paid to ceding companies and agents and brokerage fees
paid to intermediaries, less commissions received on business ceded to other
reinsurers, were $74.2 million for the year ended December 31, 1998, compared to
$58.5 million for the same period in 1997. Policy acquisition costs expressed as
a percentage of net earned premiums (the acquisition expense ratio) decreased
slightly to 30.2% in 1998 from 30.8% in 1997.
Underwriting Expenses
In 1998, Trenwick recorded underwriting expenses of $23.8 million compared to
underwriting expenses of $15.4 million in 1997. The reason for the increase in
underwriting expenses was due to the inclusion of higher expenses relating to
the business of Trenwick International since its acquisition on February 27,
1998. As a result, Trenwick recorded an underwriting loss, which is net earned
premiums less claims and claims expenses incurred, policy acquisition costs and
underwriting expenses, of $5.6 million in 1998 compared to an underwriting
profit of $6.6 million in 1997.
Other Expenses
Other expenses include $1.4 million of amortization of goodwill and other
intangibles, $7.2 million of general and administrative expenses and $18.9
million of interest expense and minority interest in subsidiary trust for the
year ended December 31, 1999 compared to $33,000 of amortization of goodwill and
other intangibles, $3.5 million of general and administrative expenses and $13.7
million for interest expense and minority interest in subsidiary trust for the
same period in 1998. The increase reflects the addition of goodwill and
increases in general and administrative expenses and interest expense in
conjunction with the acquisition of Chartwell.
Income Before Income Taxes and Extraordinary Item
Net income before income taxes decreased to $43.0 million for the year ended
December 31, 1998 compared to $47.5 million for the same period in 1997. The
decrease resulted primarily from after-tax charges of $5.7 million associated
with catastrophe losses, including Hurricanes Mitch and Georges. There were no
material catastrophe losses included in the results for 1997.
Income Taxes
The provision for income taxes for the year ended
December 31, 1998 decreased to $8.2 million compared with $11.2 million for the
same period in 1997. The effective tax rate was 19% and 24% for the years ended
December 31, 1998 and 1997, respectively. The principal factor in the decline
below the statutory rate of 35% for both periods resulted from the benefit
recognized on investments in tax-exempt securities.
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Extraordinary Loss
Trenwick incurred an extraordinary loss, net of the related tax benefit, of $1.0
million in 1997 in connection with the redemption of outstanding debt.
Net Income
Trenwick realized a net profit of $34.8 million for the year ended December 31,
1998 compared with a net profit of $35.3 million for the comparable 1997 period.
Basic earnings per share decreased 1.3% to $2.99 per share for the year ended
December 31, 1998 from $3.03 per share for the same period in 1997. Diluted net
income per share decreased 2.0% to $2.95 per share from $3.01 per share for the
year ended December 31, 1998.
Investments
Trenwick's investment objective is to fund policyholder and other liabilities in
a manner that enhances shareholder value, subject to appropriate risk
constraints. Trenwick seeks to meet this investment objective through a mix of
investments that reflect the characteristics of the liabilities they support;
diversify the types of investment risks by interest rate, liquidity, credit and
equity price risk; and achieve asset diversification by investment type,
industry, issuer and geographic location. Trenwick regularly projects duration
and cash flow characteristics of its liabilities and makes appropriate
adjustments in its investment portfolios. At December 31, 1999, Trenwick had
investments, cash and cash equivalents of $1.7 billion, an increase of 74.0%
compared to investments, cash and cash equivalents of $1.0 billion at December
31, 1998. This increase resulted principally from the acquisition of Chartwell's
invested asset base. All debt and equity investments are classified as available
for sale and reported at fair value with the unrealized gain or loss, net of
income taxes, reported in other comprehensive income. During 1999, the market
value of Trenwick's debt and equity investments decreased by $41.7 million as a
result of an overall increase in interest rates, the effect of which was
amplified by the increase in 1999 of the size of Trenwick's asset base.
During 1999, the proceeds from sales and maturities of taxable and tax-exempt
securities of $769.4 million were invested by Trenwick America Re primarily in
tax-exempt securities in the amount of $69.6 million and by Trenwick
International in debt securities issued by the British Government in the amount
of $138.2 million. Trenwick also purchased mortgage-backed and asset-backed
securities in the amount of $6.6 million, U.S. government and agency securities
of $31.4 million, securities of other governments of $60.6 million, investment
grade corporate bonds of $44.7 million and high yield corporate bonds of $29.2
million. In addition, Trenwick purchased and disposed of certificates of deposit
in the amount of $261.6 million during 1999. Also in 1999, $29.7 million of
equities were purchased.
Trenwick's debt securities consisted primarily of investment grade securities,
with 79% having a quality rating of Aa or better at December 31, 1999. High
yield, or non-investment grade debt securities carry a rating of below
BBB-/Baa3. These securities, along with unrated securities, represented less
than 2% of the portfolio at December 31, 1999 and .5% of the portfolio at
December 31, 1998.
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The average maturity of Trenwick's debt securities at December 31, 1999 was 6.8
years compared to 5.7 years at December 31, 1998 and 6.2 years at December 31,
1997. The shortening during 1998 reflected the addition of Trenwick
International's portfolio which had a much shorter average maturity. The
lengthening during 1999 reflects the longer average maturity of the Chartwell
portfolio along with the 1999 duration extension of the Trenwick International
portfolio.
Trenwick has not invested in derivative financial instruments such as futures,
forward contracts, swaps, options or other financial instruments with similar
characteristics such as interest rate caps or floors and fixed-rate loan
commitments. Trenwick's portfolio includes market sensitive instruments, such as
mortgage-backed and asset-backed securities, which amounted to approximately
$288.5 million at December 31, 1999 or 16.5% of cash and invested assets. These
investments are classified as available for sale and are not held for trading
purposes. There are various categories of mortgage-backed and asset-backed
securities that are subject to different degrees of risk from changes in
interest rates and, for those mortgage-backed and asset-backed securities that
are not agency-backed, defaults. Approximately 60.6% of Trenwick's
mortgage-backed and asset-backed securities holdings were backed by government
agencies, such as GNMA, FNMA and FHLMC, at December 31, 1999 and 45.8% at
December 31, 1998. The principal risks inherent in holding mortgage-backed and
asset-backed securities are prepayment and extension risks related to dramatic
decreases and increases in interest rates, resulting in the repayment of
principal from the underlying mortgages either earlier or later than originally
anticipated. At December 31, 1999, approximately .3% of Trenwick's
mortgage-backed and asset-backed securities holdings were invested in
mortgage-backed and asset-backed securities that are subject to more prepayment
and extension risk (such as interest- or principal-only strips) than traditional
mortgage-backed and asset-backed securities. At December 31, 1998, no such
securities were held.
Liquidity and Capital Resources
Cash Flows
Trenwick is a holding company whose principal assets are its investments in the
common stock of its operating subsidiaries. As a holding company, Trenwick's
principal source of funds consists of permissible dividends, tax allocation
payments and other statutorily permissible payments from its operating
subsidiaries together with income on the holding company's fixed-income
portfolio. Trenwick's principal uses of cash are dividends to its stockholders,
servicing its debt obligations and repurchases of its own common stock when the
pricing is attractive. Trenwick's operating subsidiaries receive cash from
premiums, investment income and proceeds from sales and maturities of portfolio
investments. They utilize cash to pay claims, purchase their own reinsurance
protections, meet operating and capital expenses and purchase fixed-income and
equity securities.
Cash used in Trenwick's operating activities in 1999 was $52.3 million compared
to cash provided by Trenwick's operating activities of $37.9 million in 1998 and
$47 million in 1997. The reduction in cash flow from operations in 1999 was due
primarily to a cash payment of $56 million in premium payments for the
reinsurance policy which provides protection against adverse development of
Chartwell's reserves following its acquisition by Trenwick and an overall
increase in claims and claims expenses paid.
In 1999, cash used for financing activities was $24.4 million compared to cash
provided by financing activities of $29.0 million in 1998. Cash used by
financing activities in 1999 includes the repayment of long-term debt of $48.4
million and the repurchase of common stock of $44.6 million, offset by $94.5
million of borrowings under a credit facility established in 1999. Cash provided
by financing activities in 1998 included proceeds from the issuance of $75
million principal amount of 6.70% Senior Notes partially offset by repurchases
of common stock of approximately $34.9 million. Included in cash provided by
financing activities in 1997 was $110 million from the issuance of the
Subordinated Capital Income Securities, partially offset by the redemption of
convertible debt of approximately $47 million.
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Trenwick's current liquidity objectives are to maximize the use of available
cash to fund ongoing operating needs, pay shareholder dividends, strategically
invest in core businesses and meet common stock repurchase objectives. During
1999, net cash generated from investing, financing and operating activities was
used to pay $44.6 million for common stock repurchases and pay $12.8 million of
dividends to shareholders. In 1998, net cash generated by investing, financing
and operating activities was used to pay $34.9 million for common stock
repurchases and pay $11.7 million of dividends to shareholders.
Dividends
Trenwick paid a quarterly dividend of $.26 per share of common stock in 1999 and
$.25 per share of common stock in 1998. Trenwick's Board of Directors reviews
Trenwick's common stock dividend each quarter. Among the factors considered by
the Board of Directors in determining the amount of each dividend are Trenwick's
results of operations and the capital requirements, growth and other
characteristics of its businesses.
Financings, Financing Capacity and Capitalization
Substantially all of Trenwick's borrowings and financings are conducted through
Trenwick Group Inc. Trenwick continually monitors existing and alternative
financing sources to support Trenwick's capital and liquidity needs, including,
but not limited to, debt issuance, preferred or common stock issuance,
intercompany borrowings and pledging or selling of assets.
Trenwick's total debt to capital ratio (total debt divided by total debt and
shareholders' equity, adjusted for unrealized gains or losses on
available-for-sale investment securities) was 43% at the end of 1999, 36% at the
end of 1998 and 25% at the end of 1997. The increases in 1999 and 1998 primarily
reflect the incurrence of indebtedness in connection with the acquisition of
Trenwick International and the assumption of indebtedness in connection with the
Chartwell acquisition.
On November 24, 1999, Trenwick entered into a $400 million credit agreement with
various lending institutions, The Chase Manhattan Bank, as Administrative Agent,
First Union National Bank, as Syndication Agent, and Fleet National Bank, as
Documentation Agent. This new credit facility provides for a $170 million,
364-day revolving credit facility with an option to pay out outstanding
borrowings under such facility over the four years following the expiration of
the 364-day period. In addition, the credit facility provides for a $230 million
five year, Lloyd's letter of credit facility, with a one year automatic renewal
option. The applicable interest rate on borrowings under the credit facility is
currently 1.3% above the London interbank offered rate or The Chase Manhattan
Bank prime commercial lending rate.
The credit facility's representations, warranties and covenants are typical for
transactions of this type and include limitations based upon Trenwick's leverage
ratio, interest coverage ratio, combined surplus and risk-based capital.
Trenwick and the banks party to the credit facility executed an amendment to the
credit facility, dated as of December 31, 1999, reducing the required minimum
consolidated tangible net worth of Trenwick from $325 million to $290 million
until June 30, 2000.
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In addition to the credit facility, Trenwick has outstanding $75 million
aggregate principal amount of 6.70% Senior Notes, which are due April 1, 2003.
Interest is payable semi-annually on April 1 and October 1 of each year;
interest payments commenced on October 1, 1998.
The notes are not subject to redemption prior to maturity. They are unsecured
obligations and rank senior in right of payment to all existing and future
subordinated indebtedness of Trenwick.
Trenwick's long-term debt obligations also include 8.82% Junior Subordinated
Deferrable Interest Debentures held by Trenwick Capital Trust I in respect of
the $110 million in 8.82% Subordinated Capital Income Securities issued by the
Trust. Under the terms of the debentures, Trenwick is not restricted from
incurring indebtedness, but is subject to limits on its ability to incur secured
indebtedness for borrowed money.
Upon consummation of the acquisition of Chartwell in 1999, Trenwick became the
successor obligor under Chartwell's Contingent Interest Notes due June 30, 2006.
The Contingent Interest Notes were issued in an aggregate principal amount of $1
million, which accrues interest at a rate of 8% per annum, compounded annually.
The interest is not payable until the maturity or earlier redemption of the
Contingent Interest Notes. In addition, the Contingent Interest Notes entitle
their holders to receive at maturity, in proportion to the principal amount of
the Contingent Interest Notes held by them, an aggregate of from $10 million up
to $55 million in contingent interest. The amount of contingent interest payable
under the Contingent Interest Notes is dependent upon the level of loss and loss
adjustment expense reserves related to business written by INSCORP prior to
1996. Settlement of the Contingent Interest Notes may be made by payment of cash
or, under certain specified conditions, by delivery of shares of Trenwick's
common stock.
Trenwick also assumed Chartwell's 10.25% Senior Notes due 2004 upon the closing
of the acquisition. As of December 31, 1999, $40.1 million in principal amount
of the Senior Notes were outstanding. On March 1, 2000, Trenwick redeemed the
remaining outstanding Senior Notes at a redemption price of 102.56% of the par
value of the notes.
Common Stock Transactions
In May 1997, Trenwick's Board of Directors authorized the repurchase of one
million shares of common stock. In September 1998, August 1999, November 1999
and December 1999, the Board of Directors authorized the repurchase of
additional shares, increasing the total number of shares of common stock which
Trenwick could purchase under the stock repurchase program to 4.6 million at
purchase prices not to exceed Trenwick's book value. Under the stock repurchase
plan, Trenwick repurchased 2,176,200 shares of common stock at a cost of
approximately $46.6 million in 1999 and an additional 829,300 shares of common
stock at a cost of approximately $13.7 million in January of 2000. Since May
1997, Trenwick has purchased an aggregate of 3,276,700 shares of common stock at
a cost of approximately $81.9 million under its stock repurchase program.
Trenwick issued 65,985 shares of common stock in 1999, 82,889 shares in 1998 and
9,782 shares in 1997 pursuant to employee benefit plans.
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Restrictions on Certain Payments within Trenwick
Because Trenwick's operations are conducted through its operating subsidiaries,
Trenwick is dependent upon the ability of its operating subsidiaries to transfer
funds, principally in the form of cash dividends, tax reimbursements and other
statutorily permissible payments. In addition to general legal restrictions on
payments of dividends and other distributions to shareholders applicable to all
corporations, Trenwick's insurance subsidiaries are subject to further
regulations that, among other things, restrict the amount of dividends and other
distributions that may be paid to their parent corporations. Management believes
that current levels of cash flow from operations and assets held at the holding
company level, together with approval of one or more extraordinary dividends
from Trenwick's operating subsidiaries, will provide Trenwick with sufficient
liquidity to meet its operating needs in the short-term (over the next twelve
months). Since the ability of Trenwick to meet its obligations in the long-term
(beyond such twelve month period) is dependent upon such factors as market
changes, insurance regulatory changes and economic conditions, no assurance can
be given that the available net cash flow will be sufficient to meet its
operating needs. Trenwick expects that, in order to repay the principal amount
of certain currently outstanding indebtedness at maturity or otherwise, it will
be required to seek additional financing or engage in asset sales or similar
transactions. There can be no assurance that sufficient funds for any of the
foregoing purposes would be available to Trenwick at such time.
Under the applicable provisions of the insurance holding company laws of the
states of domicile of most of Trenwick's U.S. insurance companies, the insurance
companies may only pay dividends without the approval of the applicable state
insurance regulator if such dividends, together with other dividends paid within
the preceding twelve months, are less than the greater of (i) 10% of the
insurer's policyholders' surplus as of the end of the prior calendar year or
(ii) the insurer's statutory net income, excluding realized capital gains, for
the prior calendar year. As a further restriction, the maximum amount of
dividends most U.S. insurers may pay is limited to its earned surplus, also
known as its unassigned funds. Any dividend in excess of the amount determined
pursuant to the foregoing formula would be characterized as an "extraordinary
dividend" requiring the prior approval of the state insurance regulator.
Under New York law, which is applicable to two of Trenwick's insurance company
subsidiaries, INSCORP and ReCor Insurance Company Inc. (ReCor), the maximum
ordinary dividend payable in any twelve month period without the approval of the
New York Insurance Department is the lesser of (i) 10% of policyholders' surplus
as shown on the company's last annual statement or any more recent quarterly
statement or (ii) the company's adjusted net investment income. Adjusted net
investment income is defined as net investment income for the twelve months
preceding the declaration of the dividend plus the excess, if any, of net
investment income over dividends declared or distributed during the period
commencing thirty-six months prior to the declaration or distribution of the
current dividend and ending twelve months prior thereto. In any case, New York
law permits the payment of an ordinary dividend by an insurer or reinsurer only
out of earned surplus.
In addition to the foregoing limitations, the New York Insurance Department, as
is its practice in any change of control situation, required Trenwick to commit
to preclude the acquired New York-domiciled insurers, INSCORP and ReCor, from
paying any dividends for two years after the merger with Chartwell without prior
regulatory approval. The foregoing restriction will expire on October 27, 2001.
Neither INSCORP nor ReCor paid any dividends in 1997, 1998 or 1999.
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Moreover, insurance holding company laws generally provide that, notwithstanding
the receipt of any dividend from a subsidiary insurer, an insurer may make
dividend payments to its parent only to the extent it is permitted to do so
under its applicable dividend restrictions.
In other words, the ability of a subsidiary insurer to pay dividends without
restriction may be impaired if its parent insurer cannot pay dividends without
restriction.
The maximum dividend permitted by law may not be indicative of an insurer's
actual ability to pay dividends, which may be constrained by business and other
regulatory considerations, such as the impact of dividends on surplus, which
could affect an insurer's ratings or competitive position, the amount of
premiums that can be written and the ability to pay future dividends.
Furthermore, beyond the limits described in the preceding paragraph, insurance
regulatory authorities often have the discretion to limit the payment of
dividends by insurance companies domiciled in their jurisdictions.
In 2000, of Trenwick's U.S. insurance subsidiaries, only Dakota Specialty could
pay a dividend or other distribution without prior approval of the applicable
insurance regulatory authority. In 2000, Dakota Specialty could pay a dividend
of $2.8 million without prior approval. During 1999, 1998 and 1997, Trenwick
America Re paid dividends of $53.4 million, $30.1 million and $8.3 million,
respectively. Chartwell Reinsurance paid dividends of $30.3 million in 1999 and
$3.0 million in 1997. Chartwell Reinsurance did not pay any dividends in 1998.
None of Trenwick's other U.S. insurance subsidiaries paid any dividends in 1999,
1998 or 1997.
Under the applicable laws of the United Kingdom, Trenwick Holdings Limited,
Chartwell Holdings Limited and their respective subsidiaries may make
shareholder distributions only from accumulated realized profits, net of
accumulated realized losses. In addition, under the U.K. Insurance Companies
Act, Trenwick International is not permitted to make any distribution that would
reduce its net assets below the required minimum margin of solvency which, as
determined under the U.K. Financial Service Authority's rules, is approximately
$16.7 million as of December 31, 1999. Trenwick International must also notify
the U.K. Financial Services Authority of any proposal to declare or pay a
dividend on any of its share capital. Under Lloyd's regulations, Chartwell
Managing Agents is not permitted to make any distribution that would cause its
assets to fall below any of Chartwell Managing Agents' share capital, minimum
net current asset margin or minimum net asset margin. As of December 31, 1999,
the highest of the three tests required Chartwell Managing Agents to maintain
approximately $1.1 million of capital.
Reinsurance
Trenwick's operating subsidiaries purchase reinsurance to reduce its exposure to
catastrophe claims and the frequency and severity of claims in all lines of
business. In 1999, 1998 and 1997, Trenwick America Re's reinsurance treaties
consisted principally of an excess of loss treaty for its facultative casualty
business and property catastrophe reinsurance treaties. In addition, Trenwick
America Re purchased an annual aggregate excess of loss ratio treaty for
casualty business effective January 1, 1999. Except for property catastrophe
reinsurance treaties, these coverages were not renewed effective January 1,
2000. Trenwick International and Chartwell Managing Agents, as is customary with
companies operating in the London market and at Lloyd's, buy larger amounts of
reinsurance to protect themselves. Reinsurance and retrocessional coverage is
customized for each class of business. Canterbury Financial purchased specific
reinsurance programs for each of the programs underwritten by its insurance
companies.
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As part of the merger with Trenwick, Chartwell purchased, at the time of the
closing of the transaction, a reinsurance policy providing for up to $100
million in coverage in order to indemnify Trenwick against unanticipated
increases in Chartwell's reserves for business written on or before the date the
merger was completed. The reinsurance policy applies to all of Chartwell's
business, including its operations at Lloyd's. In addition, as part of the
merger, Chartwell commuted several aggregate stop-loss reinsurance treaties.
Reinsurance agreements provide for recovery of a portion of certain claims and
claims expenses from reinsurers. Trenwick remains liable in the event that the
reinsurer is unable to meet its obligation; however, Trenwick holds partial
collateral under these agreements.
Regulatory Matters
Trenwick and its domestic subsidiaries are subject to regulatory oversight under
the insurance statutes and regulations of the jurisdictions in which they
conduct business, including all states of the United States and the United
Kingdom. These regulations vary from jurisdiction to jurisdiction and are
generally designed to protect ceding insurance companies and policyholders by
regulating Trenwick's financial integrity and solvency in its business
transactions and operations. Many of the insurance statutes and regulations
applicable to Trenwick's subsidiaries relate to reporting and enable regulators
to closely monitor their performance. Reports typically required the inclusion
of information concerning Trenwick's capital structure, ownership, financial
condition and general business operations.
Trenwick International is subject to the regulatory authority of the United
Kingdom Financial Services Authority. Both Chartwell Managing Agents and
Trenwick's dedicated Lloyd's underwriting entities, as a Lloyd's managing
general agent and Lloyd's corporate members, respectively, are subject to
regulation and supervision by the Council of Lloyd's. Lloyd's operates under a
self-regulatory regime under the Lloyd's Act 1982 and has the power to set,
interpret and change the rules which govern the operation of the Lloyd's market,
subject to regulation for solvency purposes by the Financial Services Authority.
Lloyd's prescribes, in respect of its managing agents and corporate members,
certain minimum standards relating to their management and control, solvency and
various other requirements. In addition, Lloyd's imposes restrictions against
persons becoming controllers and major shareholders of managing agents and
corporate members without the consent of Lloyd's first having been obtained. The
United Kingdom government has established the Financial Services Authority as a
single regulator to supervise securities, banking and insurance business,
including Lloyd's. When the Financial Services and Market Bill becomes law,
probably in late 2000, the Financial Services Authority will have wide
authorization and intervention powers in relation to Lloyd's. A consultation
process has commenced in relation to Lloyd's regulatory framework.
The National Association of Insurance Commissioners (NAIC) has adopted
Risk-Based Capital (RBC) requirements for property and casualty insurance
companies to evaluate the adequacy of statutory capital and surplus in relation
to investment and insurance risks such as asset quality, asset and liability
matching, loss reserve adequacy and other business factors. The RBC formula is
used by state insurance regulators as an early warning tool to identify, for the
purpose of initiating regulatory action, insurance companies that potentially
are inadequately capitalized. In addition, the formula defines minimum capital
standards that supplement the system of low fixed minimum capital and surplus
requirements on a state-by-state basis. Regulatory compliance is determined by a
ratio of the enterprise's regulatory total adjusted capital to its authorized
control level RBC, as defined by the NAIC. Enterprises below specific trigger
points or ratios are classified within certain levels, each of which requires
specific corrective action. The ratios of Total Adjusted Capital to Authorized
Control Level RBC for each of Trenwick's United States insurance company
subsidiaries exceeded all of the RBC trigger points at December 31, 1999, 1998
and 1997.
15
<PAGE>
In March 1998, the NAIC adopted the Codification of Statutory Accounting
Principles (Codification). The Codification, which is intended to standardize
regulatory accounting and reporting for the insurance industry, is proposed to
be implemented January 1, 2001. The Codification provides guidance for areas
where statutory accounting has been silent and changes current statutory
accounting in some areas. However, statutory accounting principles will continue
to be established by individual state laws and permitted practices. Effective
January 1, 2001, Connecticut, New York, Minnesota and North Dakota, the states
of domicile of Trenwick's U.S. insurance subsidiaries, are adopting the
Codification. It is uncertain what effect adoption of the Codification for the
preparation of the statutory financial statements of Trenwick's U.S. insurance
subsidiaries would have on those statutory financial statements.
Quantitative and Qualitative Disclosure About
Market Risk
The following sections address the significant market risks associated with
Trenwick's business activities as of the years ended December 31, 1999 and 1998.
The 1999 risk analysis differs from that of 1998 because it includes the assets
and liabilities of the Chartwell group. The 1998 comparative data only reflects
Trenwick information. Trenwick's primary market risk exposures are: foreign
currency exchange risk, in particular the U.S. dollar to the British pound
sterling; interest rate risk on fixed and variable rate U.S. dollar and British
pound sterling denominated short and long-term instruments; and equity price
risk.
With respect to the Trenwick investment portfolio, the risk management strategy
is to place its investments with high credit quality issuers and to limit the
amount of credit exposure with respect to particular ratings categories and any
one issuer. Trenwick selects investments with characteristics such as duration,
yield, currency and liquidity to reflect the underlying characteristics of
related estimated claim liabilities.
In 1999, Trenwick allocated a portion of its bond portfolio to high yield
investments. While these investments are more susceptible to credit risk, their
total market value represents less than 2% of total investments, and therefore,
management believes that the exposure to credit risk is not material. Trenwick
has no derivatives and its investments do not contain terms that may result in
potential losses due to leverage.
Limited information is available with respect to the investments held by
Chartwell Managing Agents' syndicates, and therefore, risk information provided
does not include such data. Some or all of the risks described in this section
may apply to the investments held by Chartwell Managing Agents' syndicates.
The investment portfolio and borrowings of Trenwick are summarized in the Notes
to the Financial Statements.
16
<PAGE>
Foreign Currency Exchange Rate Risk
Foreign currency risk is the risk that Trenwick will incur economic losses due
to adverse changes in foreign currency exchange rates. This risk arises from
Trenwick's international operations, debt obligations and securities denominated
in foreign currencies and foreign equity investments. Trenwick generally
conducts its international businesses through foreign operating entities which
generally maintain assets and liabilities in local currencies, substantially
limiting exchange rate risk to net assets denominated in the foreign currency
which is the British pound sterling. At December 31, 1999 and 1998, Trenwick's
net investment in foreign subsidiaries was approximately $24.1 million and
$133.9 million, respectively. Debt obligations denominated in foreign currencies
were $19.4 million and foreign equity investments were $2.9 million at December
31, 1999. Trenwick did not hold any debt obligations denominated in foreign
currencies or foreign equity investments at December 31, 1998.
Trenwick's reinsurance, international insurance and Lloyd's operations all have
exposures to movements in various currencies around the world, (particularly the
British pound sterling, the Euro and the Canadian dollar) as such businesses are
denominated in those currencies. Therefore, changes in currency exchange rates
affect Trenwick's Balance Sheet, Statement of Operations and Statement of Cash
Flows. This exposure is somewhat mitigated by the fact that premiums received
are invested in the same currency portfolios, to partially offset related unpaid
claims and claims expense liabilities denominated in the same currency.
Management estimates that a 10% immediate unfavorable change in each of the
foreign currency exchange rates to which Trenwick is exposed as of December 31,
1999 would decrease the fair value of Trenwick's foreign denominated net assets
by approximately $9.1 million, which is comprised of $7.4 million to the British
pound sterling, $1.5 million to the Canadian dollar and an aggregate of $.2
million to all other foreign currencies. At December 31, 1998, the same 10%
shift in currency exchange rates primarily the British pound sterling) would
result in a potential loss in fair value of $18.2 million. Trenwick has not
experienced a 10% shift in currency exposure in either 1998 or 1999.
Interest Rate Risk
Trenwick's fixed maturity investments and indebtedness are subject to interest
rate risk. Increases and decreases in prevailing interest rates generally
translate into decreases and increases in the fair value of fixed maturity
investments and the interest payable on Trenwick's outstanding variable rate
debt. Additionally, the fair value of interest rate sensitive instruments may be
affected by the creditworthiness of the issuer, a prepayment option, relative
values of alternative investments, liquidity of the investment and other general
market conditions.
The table below summarizes the estimated effects of hypothetical increases and
decreases in interest rates. It is assumed that the changes occur immediately
and uniformly to each category of instrument containing interest rate risks. The
hypothetical changes in market interest rates reflect what could be deemed best
or worst case scenarios. Significant variations in market interest rates could
produce changes in the timing of repayments due to prepayment options available.
The fair value of such instruments could be affected and therefore actual
results might differ from those reflected in the following table:
<TABLE>
<CAPTION>
Estimated Estimated
Hypothetical Fair Gain (Loss)
Change in Value After After
Interest Rate Hypothetical Hypothetical
Fair Value at (bp=basis Change in Change in
(dollars in thousands) Dec 31, 1999 points) Interest Rate Interest Rate
<S> <C> <C> <C> <C>
Assets(1)
U.S. treasury 1,404,248 100 bp decrease 1,467,926 63,678
100 bp increase 1,343,017 (61,231)
200 bp increase 1,284,971 (119,276)
300 bp increase 1,226,926 (177,322)
Liabilities(2)
Borrowings 344,775 100 bp decrease 356,579 11,805
100 bp increase 334,419 (10,355)
200 bp increase 325,231 (19,544)
300 bp increase 316,994 (27,781)
Aggregate 1,059,473 100 bp decrease 1,111,347 51,874
100 bp increase 1,008,598 (50,876)
200 bp increase 959,741 (99,733)
300 bp increase 909,932 (149,541)
</TABLE>
17
<PAGE>
(1) Excludes investments held by Chartwell Managing Agents managed syndicates,
as information is not available, but includes preferred shares, which are
grouped with equities on the face of the Balance Sheet but more closely resemble
debt instruments for risk analysis purposes.
(2) Liabilities include Trust Preferred for this analysis.
<TABLE>
<CAPTION>
Estimated Estimated
Hypothetical Fair Gain (Loss)
Change in Value After After
Interest Rate Hypothetical Hypothetical
Fair Value at (bp=basis Change in Change in
(dollars in thousands) Dec 31, 1998 points) Interest Rate Interest Rate
<S> <C> <C> <C> <C>
Assets(1)
U.S. treasury 773,144 100 bp decrease 802,195 29,051
100 bp increase 743,831 (29,313)
200 bp increase 714,351 (58,793)
300 bp increase 687,113 (86,031)
Liabilities
Borrowings 188,900 100 bp decrease 206,394 17,494
100 bp increase 174,233 (14,667)
200 bp increase 161,766 (27,134)
300 bp increase 151,033 (37,867)
Aggregate 584,244 100 bp decrease 595,801 11,557
100 bp increase 569,598 (14,646)
200 bp increase 552,585 (31,659)
300 bp increase 536,080 (48,164)
</TABLE>
(1) Does not include Trenwick International assets.
Trenwick has not experienced unrealized gains or losses to the extent indicated
on the table above.
18
<PAGE>
Equity Price Risk
The carrying values of investments subject to equity price risks are based on
quoted market prices or management's estimates of fair value as of the balance
sheet date. Market prices are subject to fluctuation and, consequently, the
amount realized in the subsequent sale of an investment may significantly differ
from the reported market value. Fluctuation in the market price of a security
may result from perceived changes in the underlying economic characteristics of
the investee, the relative price of alternative investments and general market
conditions. Furthermore, amounts realized in the sale of a particular security
may be affected by the relative quantity of the security being sold.
Of Trenwick's $110.6 million equity portfolio at December 31, 1999, $56.6
million of common equity investments is subject to equity risk. The total also
includes $54.0 million of preferred shares, which are included in the interest
rate risk analysis, as their characteristics more closely resemble debt
instruments. Additionally, $19.5 million of other investments generally
represent partnership interests that more closely resemble equity investments.
Trenwick's potential exposure on equity securities of $56.6 million and
partnership interests of $19.5 million is estimated in terms of an immediate 10%
drop in equity prices across all equity securities holdings from those
prevailing at December 31, 1999 which would result in a $7.6 million loss.
Trenwick's actual loss in fair value on a quarterly basis never exceeded this
amount during 1999. Trenwick's common equity portfolio of $49.2 million at
December 31, 1998, was subject to changes in value based on changes in equity
prices. Trenwick's potential exposure from those equity securities, estimated in
terms of fair value, to an immediate 10% drop in equity prices across all equity
securities holdings from those prevailing at December 31, 1998 would have been
$4.9 million. Trenwick's actual loss in fair value on a quarterly basis never
exceeded this amount during 1998.
The fair value estimates shown are based on the composition of the equity
security portfolio at year-end and these exposures will change as a result of
ongoing portfolio activities in response to management's assessment of changing
market conditions and available investment opportunities.
The above analyses do not take into account any correlation among foreign
currency exchange rates, or any correlation among various markets (i.e., the
fixed income markets and foreign exchange and equity markets). Trenwick's actual
experience may differ from the results noted above due to the correlation
assumptions utilized, or if events occur that were not included in the
methodology, such as significant liquidity or market events. The selection of
the amount of increases or decreases in currency exchange rates, interest rates
and equity values in the above analyses should not be construed as a prediction
of future market events, but rather, to illustrate the potential impact of such
an event.
Goodwill and Other Acquired Intangible Assets
Goodwill was $153.8 million at December 31, 1999, or approximately 33.3% of
consolidated shareholders' equity. Goodwill represents the unamortized excess of
purchase price over the fair value of net assets of acquired entities. Other
intangibles represent Trenwick's acquisition of its prospective participation of
$9.5 million on syndicate 839 which entitles one of its U.K. subsidiaries to
increase its syndicate premium limit for the 2000 year of account to $344.0
million. The amortization of goodwill and other acquired intangible assets was
$1.4 million in 1999, or approximately 6.7% of the pre-tax loss. Trenwick
amortizes goodwill and other acquired intangibles on a straight-line basis over
twenty-five years and five years, respectively. The risk associated with the
carrying value of goodwill and other acquired intangible assets is whether
future operating income (before amortization of goodwill and other acquired
intangible assets) will be sufficient on an undiscounted basis to recover the
carrying value. Trenwick regularly evaluates the recoverability of goodwill and
other acquired intangible assets and believes such amounts are currently
recoverable. However, any significant change in the useful lives of goodwill or
other acquired intangible assets, as estimated by management, could have a
material adverse effect on Trenwick's results of operations and financial
condition.
19
<PAGE>
Accounting Standards
Accounting for Derivative Instruments and Hedging Activities - SFAS No. 133
In June 1998, the Financial Accounting Standards Board (FASB) issued Statement
of Financial Accounting Standards (SFAS) No. 133, "Accounting for Derivative
Instruments and Hedging Activities," which becomes effective for Trenwick on
January 1, 2001. SFAS No. 133 establishes accounting and reporting standards for
derivative instruments, including certain derivative instruments embedded in
other contracts, and for hedging activities. Trenwick will be required to
recognize all derivatives as either assets or liabilities in the statement of
financial position and measure those instruments at fair value. The accounting
for a change in the fair value of a derivative in earnings or other
comprehensive income will depend on the intended use of the derivative and the
resulting designation. Derivatives can be designated as (a) a hedge of the
exposure to changes in the fair value of a recognized asset or liability or a
firm commitment, (b) a hedge of the exposure to variable cash flows of a
forecasted transaction, or (c) a hedge of the foreign currency exposure of a net
investment in foreign operations, an unrecognized firm commitment, an
available-for-sale security, or a foreign currency denominated forecasted
transaction.
The difference between a derivative's previous carrying amount and its fair
value at the date of implementation of SFAS No. 133 shall be reported as a
transition adjustment. Such adjustment shall be reported in net income or other
comprehensive income as the effect of a change in accounting principle and
presented in a manner similar to the cumulative effect of a change in accounting
principle in accordance with Accounting Principles Board Opinion No. 20,
"Accounting Changes." Trenwick is currently reviewing the impact of the
implementation of SFAS No. 133 on its financial statements.
The Euro
On January 1, 1999, eleven of the fifteen member countries of the European Union
established a fixed conversion ratio between their local currencies and a
newly-formed currency, the "Euro." The Euro began trading on foreign currency
exchanges on January 1, 1999. Beginning in January 2002, coins and paper
currency denominated in Euros will be issued and local currencies of the eleven
countries will be withdrawn from circulation. As Trenwick conducts a
considerable amount of business in countries participating in the Euro, work was
undertaken in 1998 to ensure that the introduction of the Euro would have no
adverse effect on Trenwick's business. Consequently, Trenwick modified its
computer systems to accommodate transactions denominated in the Euro. The total
cost for implementing these changes was not material. Trenwick believes the Euro
conversion will not have a material impact on its consolidated financial
position or results from operations.
Safe Harbor Disclosure
In connection with the "safe harbor" provisions of the Private Securities
Litigation Reform Act of 1995, Trenwick sets forth below cautionary statements
identifying important risks and uncertainties that could cause its actual
results to differ materially from those that might be projected, forecasted or
estimated in its "forward-looking statements" within the meaning of Section 27A
of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of
1934, made by or on behalf of Trenwick in this annual report and in press
20
<PAGE>
releases, written statements or documents filed with the Securities and Exchange
Commission, or in its communications and discussions with investors and analysts
in the normal course of business through meetings, phone calls and conference
calls. Such statements may include, but are not limited to, projections of
premium revenue, investment income, other revenue, losses, expenses, earnings
(including earnings per share), cash flows, plans for future operations, common
shareholders' equity (including book value per share), investments, financing
needs, capital plans, dividends, plans relating to products or services of
Trenwick and estimates concerning the effects of litigation or other disputes,
as well as assumptions for any of the foregoing and generally expressed with
words such as "believes," "estimates," "expects," "anticipates," "plans,"
"projects," "forecasts," "goals," "could have," "may have," and similar
expressions. Trenwick, as a matter of policy, does not make any specific
projections as to future earnings nor does it endorse any projections regarding
future performance that may be made by others.
Forward-looking statements involve known and unknown risks and uncertainties,
which may cause Trenwick's results to differ materially from such
forward-looking statements. These risks and uncertainties include, but are not
limited to, the following:
- Changes in the level of competition in the domestic and international
reinsurance or primary insurance markets that affect the volume or profitability
of Trenwick's property/casualty business. These changes include, but are not
limited to, changes in the intensity of price competition, the entry of new
competitors, existing competitors exiting the market and the development of new
products by new and existing competitors;
- Changes in the demand for reinsurance, including changes in ceding companies'
risk retentions and changes in the demand for excess and surplus lines insurance
coverages;
- The ability of Trenwick to execute its strategies in its property/casualty
operations;
- Catastrophe losses in Trenwick's domestic and international property/casualty
businesses;
- Adverse development on property/casualty claims and claims expense liabilities
related to business written in prior years, including, but not limited to,
evolving case law and its effect on environmental and other latent injury
claims, changing government regulations, newly identified toxins, newly reported
claims, new theories of liability, such as possible Year 2000 computer-related
losses, or new insurance and reinsurance contract interpretations;
- Changes in inflation that affect the profitability of Trenwick's current
property/casualty business or the adequacy of its property/casualty claims and
claims expense liabilities and policy benefit liabilities related to prior
years' business;
- Changes in Trenwick's property/casualty retrocessional arrangements;
- Lower than estimated retrocessional or reinsurance recoveries on unpaid
losses, including, but not limited to, losses due to a decline in the
creditworthiness of Trenwick's retrocessionaires or reinsurers;
21
<PAGE>
- Increases in interest rates, which may cause a reduction in the market value
of Trenwick's fixed income portfolio, and its common shareholders' equity;
- Decreases in interest rates which may cause a reduction of income earned on
new cash flow from operations and the reinvestment of the proceeds from sales or
maturities of existing investments;
- Decline in the value of Trenwick's equity investments;
- Changes in the composition of Trenwick's investment portfolio;
- Credit losses on Trenwick's investment portfolio;
- Adverse results in litigation matters, including, but not limited to,
litigation related to environmental, asbestos and other potential mass tort
claims;
- The impact of mergers and acquisitions;
- Gains or losses related to changes in foreign currency exchange rates; and
- Changes in Trenwick's capital needs.
In addition to the factors outlined above that are directly related to
Trenwick's businesses, Trenwick is also subject to general business risks,
including, but not limited to, adverse state, federal or foreign legislation and
regulation, adverse publicity or news coverage, changes in general economic
factors and the loss of key employees.
The facts set forth above should be considered in connection with any
forward-looking statement contained in this Annual Report. The important factors
that could affect such forward-looking statements are subject to change, and
Trenwick does not intend to update any forward-looking statement or the
foregoing list of important factors. By this cautionary note Trenwick intends to
avail itself of the safe harbor from liability with respect to forward-looking
statements provided by Section 27A and Section 21E referred to above.
22
<PAGE>
TRENWICK GROUP INC.
CONSOLIDATED BALANCE SHEET
<TABLE>
<CAPTION>
December 31,
1999 1998
(dollars in thousands)
<S> <C> <C>
Assets
Securities available for sale at fair value: Debt securities
(amortized cost: $1,325,438 and $867,552) $1,311,361 $ 893,020
Equity securities (cost: $107,946 and $44,342) 110,666 49,188
Other investments 19,446 -
Investments held by managed syndicates 137,745 -
Total investments 1,579,218 942,208
Cash and cash equivalents 125,954 63,003
Cash and cash equivalents held by managed syndicates 44,687 -
Accrued investment income 26,122 15,974
Premiums in process of collection 270,455 138,550
Reinsurance recoverable balances, net 644,578 140,173
Prepaid reinsurance premiums 100,000 22,632
Goodwill 153,824 1,605
Deferred policy acquisition costs 78,896 35,261
Net deferred income taxes 97,442 14,101
Current income taxes receivable 27,292 2,544
Deposits 20,227 -
Other assets 71,904 16,210
Total asset $3,240,599 $1,392,261
Liabilities and common stockholders' equity
Liabilities
Unpaid claims and claims expenses $1,964,139 $ 682,428
Unearned premium income 379,684 152,051
Senior credit facilities 94,501 -
6.70% senior notes due 2003 75,000 75,000
10.25% senior notes due 2004 39,831 -
Contingent interest notes 34,699 -
Other long term debt 4,874 -
Other liabilities 75,541 24,753
Total liabilities 2,668,269 934,232
Company-obligated mandatorily redeemable preferred
capital securities of subsidiary trust holding solely
junior subordinated debentures of Trenwick Group Inc. 110,000 110,000
Minority interest 81 -
Common stockholders' equity
Common stock, $.10 par value,
30,000,000 shares authorized,
16,888,981 and 11,051,394 shares
outstanding 1,689 1,105
Additional paid-in-capital 291,361 124,180
Deferred compensation under stock award plan (3,553) (2,905)
Retained earnings 182,477 206,312
Accumulated other comprehensive income (9,725) 19,337
Total common stockholders' equity 462,249 348,029
Total liabilities and common stockholders' equity $3,240,599 $1,392,261
</TABLE>
The accompanying notes are an integral part of these statements.
23
<PAGE>
TRENWICK GROUP INC.
CONSOLIDATED STATEMENTS OF OPERATIONS AND
COMPREHENSIVE INCOME
<TABLE>
<CAPTION>
Year ended December 31,
1999 1998 1997
(in thousands except per share data)
<S> <C> <C> <C>
Revenues
Net premiums earned $325,114 $245,561 $190,156
Net investment income 66,394 56,316 48,402
Equity in net earnings of investees 188 - -
Net realized investment gains 1,916 9,016 2,304
Other income 673 421 10
Total revenues 394,285 311,314 240,872
Expenses
Claims and claims expenses incurred 254,538 153,135 109,554
Policy acquisition costs 96,095 74,197 58,549
Underwriting expenses 37,389 23,795 15,425
General and administrative expenses 7,182 3,461 -
Interest expense 9,176 3,954 894
Amortization expense 1,423 33 -
Minority interest in subsidiary trust 9,702 9,702 8,920
Total expenses 415,505 268,277 193,342
Income (loss) before income taxes and
extraordinary item (21,220) 43,037 47,530
Income tax (benefit) expense (10,172) 8,245 11,241
Income (loss) before extraordinary item (11,048) 34,792 36,289
Extraordinary loss on debt redemption,
net of $558 income tax benefit - - (1,037)
Net income (loss) $(11,048) $ 34,792 $ 35,252
Basic earnings per share
Income (loss) before extraordinary item $(.94) $2.99 $3.12
Net income (loss) $(.94) $2.99 $3.03
Diluted earnings per share
Income (loss) before extraordinary item $(.94) $2.95 $3.01
Net income (loss) $(.94) $2.95 $3.01
Comprehensive income
Net income (loss) $(11,048) $ 34,792 $ 35,252
Other comprehensive income (loss)
Unrealized investment gains (losses) (39,779) 8,183 15,316
Realized investment gains included in
net income (1,916) (9,016) (2,304)
Foreign currency translation adjustment (3,302) (553) -
Income tax benefit (expense) applicable
to other comprehensive income 15,935 478 (4,556)
Total other comprehensive income (loss) (29,062) (908) 8,456
Comprehensive income (loss) $(40,110) $ 33,884 $ 43,708
</TABLE>
The accompanying notes are an integral part of these statements.
24
<PAGE>
TRENWICK GROUP INC.
CONSOLIDATED STATEMENT OF CHANGES
IN STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
Year ended December 31,
1999 1998 1997
(dollars in thousands except per share data)
<S> <C> <C> <C>
Common stockholders' equity,
beginning of year $348,029 $357,649 $265,753
Common stock, $.10 par value, and additional
paid-in-capital
Common shares issued in exchange for
Chartwell shares (7,964,998 shares) 209,400 - -
Fair value of stock options issued
in exchange for Chartwell options 3,632 - -
Exercise of employer stock options
(122,195 and 76,750 shares) - 1,536 956
Restricted common stock awarded
(65,985, 82,889, and 9,782 shares) 1,914 2,952 327
Restricted common stock awards cancelled
(8,827 and 2,133 shares) (284) - (42)
Income tax benefit (expense) from
Additional compensation deductions
Allowable for income tax purposes (28) 1,321 626
Conversion of debentures (1,783,926 shares) - - 57,780
Common stock purchased and retired
(2,184,569, 1,104,750 and 5,091 shares) (46,869) (35,433) (171)
Deferred compensation under stock award plans
Restricted common stock awarded (1,914) (2,952) (327)
Restricted common stock awards cancelled 284 - 42
Compensation expense recognized 982 770 543
Retained earnings
Net income (loss) (11,048) 34,792 35,252
Cash dividends
($1.04, $1.00 and $.97 per share) (12,787) (11,698) (11,546)
Accumulated other comprehensive income
Other comprehensive income (loss) (29,062) (908) 8,456
Common stockholders' equity,
end of year $462,249 $348,029 $357,649
</TABLE>
The accompanying notes are an integral part of these statements.
25
<PAGE>
TRENWICK GROUP INC.
CONSOLIDATED STATEMENT OF CASH FLOWS
<TABLE>
<CAPTION>
Year ended December 31,
1999 1998 1997
(in thousands)
<S> <C> <C> <C>
Cash flows for operating activities
Premiums collected $386,087 $242,620 $149,351
Ceded premiums paid (138,622) (53,643) (10,026)
Claims and claims expenses paid (369,033) (184,386) (117,916)
Claims and claims expenses recovered 56,897 25,815 2,841
Underwriting expenses paid (30,579) (27,378) (13,753)
Cash provided by (used for)
underwriting activities (95,250) 3,028 10,497
Net investment income received 71,858 59,443 50,469
Service and other income received,
net of expenses 18 91 -
General and administrative expenses paid (7,182) (3,461) -
Interest expense and subsidiary trust
dividends paid (19,946) (12,276) (5,364)
Income taxes paid (1,796) (8,956) (8,592)
Cash provided by (used for)
operating activities (52,298) 37,869 47,010
Cash flows for investing activities
Purchases of debt securities (647,670) (537,787) (203,554)
Sales of debt securities 372,225 116,895 33,980
Maturities of debt securities 397,165 445,800 78,770
Purchases of equity securities (29,656) (11,538) (12,967)
Sales of equity securities 21,560 15,088 5,009
Acquisition of subsidiary,
net of cash acquired 74,229 (39,799) -
Additions to premises and equipment (1,783) (4,596) (227)
Other, net (55) - -
Cash provided by (used for)
investing activities 186,015 (15,937) (98,989)
Cash flows for financing activities
Issuance of other long-term debt 94,473 - -
Issuance of senior notes - 75,000 -
Issuance of mandatorily redeemable
Preferred capital securities - - 110,000
Repayment of other long-term debt (48,417) - -
Issuance costs of senior notes and
capital securities - (922) (1,669)
Issuance costs of long-term debt (4,055) - -
Redemption of convertible debentures - - (46,997)
Issuance of common stock - 1,536 956
Repurchase of common stock (44,604) (34,880) (171)
Dividends paid (12,787) (11,698) (11,546)
Other, net (9,056) - -
Cash provided by (used for)
financing activities (24,446) 29,036 50,573
Effect of exchange rate on cash (1,633) (812) -
Change in cash and cash equivalents 107,638 50,156 (1,406)
Cash and cash equivalents,
beginning of year 63,003 12,847 14,253
Cash and cash equivalents, end of year $170,641 $ 63,003 $12,847
</TABLE>
The accompanying notes are an integral part of these statements.
26
<PAGE>
TRENWICK GROUP INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1
Organization
and Summary of
Significant
Accounting
Policies
Organization
Trenwick Group Inc. (Trenwick or the Company) is a holding company whose
principal subsidiaries underwrite specialty insurance and reinsurance.
Trenwick's principal operating subsidiaries include Trenwick America Reinsurance
Corporation (Trenwick America Re), Chartwell Reinsurance Company (Chartwell
Reinsurance), The Insurance Corporation of New York (INSCORP), Dakota Specialty
Insurance Company (Dakota), Trenwick International Limited (Trenwick
International) and Chartwell Managing Agents Limited (CMA), a managing agency in
the Lloyd's marketplace.
Trenwick America Re, located in Stamford, Connecticut, reinsures property and
casualty risks primarily written by U.S. insurance companies. Trenwick America
Re underwrites treaty reinsurance. Trenwick America Re is domiciled in
Connecticut and is licensed, authorized or approved to write reinsurance in all
50 states and the District of Columbia.
Chartwell Reinsurance, located in Stamford, Connecticut, underwrote treaty
reinsurance for casualty, property, marine and aviation risks prior to its
acquisition by the Company. Chartwell Reinsurance is currently domiciled in
Minnesota and is licensed, authorized or approved to write reinsurance in 49
states and the District of Columbia. Chartwell Reinsurance is in the process of
re-domesticating to Connecticut and changing its name to Chartwell Insurance
Company. It will be used by the Company to underwrite primary insurance in the
future.
INSCORP, located in Jericho, New York, is a primary insurance company that
develops property and casualty insurance programs through specialty production
sources focusing on a specific line of business and geographic region. INSCORP
is domiciled in New York and is licensed, authorized or approved to transact
business in all 50 states, the District of Columbia and Canada.
Trenwick International, headquartered in London, England, underwrites specialty
insurance and reinsurance of risks primarily located outside the U.S. Trenwick
International's business principally consists of insurance and facultative
reinsurance of specialty classes. Trenwick International also underwrites
property and casualty treaty reinsurance. A branch office in Paris specializes
in facultative reinsurance of large, technically complex property risks.
Trenwick International is domiciled in England and is authorized to write
insurance in over 30 countries and participates in the London market for
worldwide reinsurance.
Trenwick, through corporate subsidiaries, participates in the underwriting of
Lloyd's syndicates managed by Chartwell Managing Agents Limited (CMA) by
providing funds at Lloyd's, primarily in the form of letters of credit
supporting underwriting capacity. The syndicates in which the Company
participates underwrite aviation, marine and non-marine risks.
27
<PAGE>
CMA is the eighteenth largest managing agency at Lloyd's, managing three Lloyd's
syndicates for the 2000 year of account. CMA is domiciled in England and, as a
Lloyd's managing general agent, is subject to regulation and supervision by the
Council of Lloyd's.
Basis of Presentation
The consolidated financial statements include the accounts of the Company and
all subsidiaries. Significant intercompany accounts and transactions have been
eliminated in consolidation. Certain items in the financial statements have been
reclassified to conform with the 1999 presentation.
The accompanying consolidated financial statements have been prepared in
conformity with generally accepted accounting principles (GAAP) in the U.S.
which require management to make estimates and assumptions that affect the
reported amounts of assets and liabilities and disclosure of contingent assets
and liabilities at the date of the financial statements and the reported amounts
of revenues and expenses during the reporting period. Actual results could
differ from those estimates. The following is a summary of significant
accounting policies.
Investments and Cash Equivalents
Trenwick has classified all of its debt and equity securities as "available for
sale" and reported them at fair value with net unrealized gains and losses
included in other comprehensive income, net of related deferred income taxes.
The fair value of debt securities and equity securities is estimated using
quoted market prices or broker dealer quotes. Cash equivalents represent
investments with maturities at date of purchase of three months or less and are
carried at cost which approximates fair value.
Investments in companies in which the Company has the ability to exercise
significant influence over the operating and financial policies of the investees
are accounted for under the equity method. In addition, limited partnerships in
which the Company holds greater than 3% interest are accounted for under the
equity method.
Realized gains or losses on disposition of investments are determined on the
basis of the specific identification method. Investment income consisting of
dividends and interest, net of investment expenses, is recognized in income when
earned. The amortization of premiums and accretion of discount for debt
securities is computed utilizing the interest method. The effective yield
utilized in the interest method is adjusted when sufficient information exists
to estimate the probability and timing of prepayments on mortgage-backed and
asset-backed securities. The net investment in the security is adjusted to the
amount that would have existed had the new effective yield been applied since
the acquisition of the security and that adjustment is included in net
investment income.
The Company has included in the consolidated balance sheet its pro-rata share of
the investments and cash and cash equivalents held by CMA's managed syndicates.
Such pro-rata share is determined based on the Company's percentage of capacity
owned through its dedicated corporate capital vehicles.
Revenues
Insurance and reinsurance premiums are earned (net of reinsurance ceded) on a
pro-rata basis over the related contract period. Unearned premium income
represents the portion of premiums applicable to the unexpired portion of
premium coverage with renewal dates later than year-end. Such reserves are
computed by pro-rata methods for direct business and are established based on
reports received from ceding companies for reinsurance. Premiums on contracts
are accrued on an estimated basis throughout the term of such contracts. These
estimates may change in the near term. Retrospectively rated and other
experience rated reinsurance contracts are estimated and accrued for based on
the difference between total costs before and after the experience under the
contract (the with-and-without method). These estimates of experience to date
are based on statistical data with subsequent adjustments recorded in the period
in which they become known.
28
<PAGE>
Deposits
Reinsurance contracts that do not meet insurance accounting risk transfer
requirements are classified as deposits. These deposits are treated as financing
transactions and are credited or charged with interest income or expense
according to contract terms. Cash flows from these deposit transactions are
included in "cash flows for financing activities" in the consolidated statement
of cash flows.
Policy Acquisition Costs
Policy acquisition costs are stated net of policy acquisition costs ceded and
primarily consist of commissions and brokerage expenses incurred at policy or
contract issue date. These costs vary with, and are primarily related to, the
acquisition of business and are deferred and amortized over the period in which
the related premiums are earned. Deferred policy acquisition costs are reviewed
periodically to determine that they do not exceed recoverable amounts after
allowing for anticipated investment income.
Reserve for Unpaid Claims and Claims Expenses
Claims are recorded as incurred so as to match such costs with premiums over the
contract periods. The amount provided for unpaid claims consists of any unpaid
reported claims and estimates for incurred but not reported claims, net of
salvage and subrogation. The estimates for claims incurred but not reported were
developed based on the Company's historical claims experience and an actuarial
evaluation of expected claims experience. Insurance liabilities are based on
estimates and the ultimate liability may vary from such estimates. Any
adjustments to these estimates are reflected in income when known.
Income Taxes
Income taxes are provided based on income reported in the financial statements.
Deferred income taxes are provided based on an asset and liability approach
which requires the recognition of deferred income tax assets and liabilities for
the expected future tax consequences of temporary differences between the
financial statement carrying amounts and the tax bases of assets and
liabilities.
Provision for U. S. income taxes on undistributed earnings of foreign
subsidiaries is made only on those amounts in excess of the funds considered to
be permanently reinvested. Repatriation of undistributed earnings of non-U.S.
subsidiaries is done only when it is tax efficient to do so.
29
<PAGE>
Goodwill and Other Acquired Intangible Assets
Goodwill represents the unamortized excess of purchase price over the fair value
of net assets of acquired entities. Other acquired intangible assets represent
Trenwick's acquisition of its prospective participation of $9,485,000 on
syndicate 839, which entitled one of its U.K. subsidiaries to increase its
syndicate premium limit for the 2000 year of account to $344,000,000. The
Company amortizes goodwill and other acquired intangible assets on a
straight-line basis over 25 years and 5 years, respectively. On a periodic
basis, the Company estimates the future undiscounted cash flows of the business
to which it relates in order to ensure that the carrying value of goodwill and
other acquired intangible assets has not been impaired. Amortization charged to
operations for each of the years ended December 31, 1999 and 1998 was $1,423,000
and $33,000, respectively. Accumulated amortization of goodwill at December 31,
1999 and 1998 was $1,456,000 and $33,000, respectively.
Stock-Based Compensation
Trenwick grants stock options for a fixed number of common shares to employees
and non-employee directors with an exercise price equal to the market value of
the shares at the date of grant. The accounting standard, "Accounting for
Stock-Based Compensation," supersedes the previous opinion and establishes a
fair value-based method of accounting for stock-based compensation plans.
However, it permits an entity to continue to apply the accounting provisions of
Accounting Principles Board Opinion, "Accounting for Stock Issued to Employees,"
and make pro forma disclosures of net income and earnings per share, as if the
fair market value-based method had been applied. Trenwick continues to account
for the stock option grants in accordance with the previous opinion and has
included the pro forma disclosures required by the fair value-based method in
Note 10.
Earnings Per Share
Trenwick adopted the accounting standard, "Earnings Per Share," which specifies
the computation, presentation and disclosure requirements of earnings per share
and supersedes the previous standard. It requires a dual presentation of basic
and diluted earnings per share. Basic earnings per share, which excludes the
effect of common stock equivalents, replaces primary earnings per share. Diluted
earnings per share, which utilizes the average market price per share as opposed
to the greater of the average market price per share or ending market price per
share when applying the treasury stock method in determining common stock
equivalents, replaces fully-diluted earnings per share.
Minority Interest
Minority interest represents the minority stockholders' proportionate share of
the equity of certain subsidiaries of Chartwell UK.
Premises and Equipment
Premises and equipment, including leasehold improvements are included in other
assets in the accompanying Consolidated Balance Sheet and are recorded at cost
and are amortized or depreciated using the straight-line method over their
useful lives. Accumulated amortization and depreciation was $6,863,000 and
$5,703,000 as of December 31, 1999 and 1998, respectively.
Issuance Costs of Capital Securities and Other Debt
The issuance costs of the capital securities, senior notes and senior credit
facilities are being amortized over the term of the related financial instrument
using the interest method. Accumulated amortization was $421,000 and $129,000 as
of December 31, 1999 and 1998, respectively.
30
<PAGE>
Insurance Brokerage Assets and Liabilities
The following fiduciary assets and liabilities maintained by the Company's
insurance agency subsidiaries on behalf of the insureds are presented net in the
consolidated financial statements at December 31, 1999 (in thousands):
Cash $ 3,000
Accounts receivable 31,603
Accounts payable (34,603)
Comprehensive Income
Trenwick adopted the accounting standard, "Reporting Comprehensive Income,"
which establishes standards for reporting and presentation of comprehensive
income and its components. Comprehensive income comprises net income and other
comprehensive income. Other comprehensive income consists of the change in the
net unrealized appreciation of investments and the change in foreign currency
translation adjustments, both net of income taxes.
Foreign Exchange
The assets and liabilities of foreign operations whose functional currency is
other than the U.S. dollar are translated at the rate of exchange in effect at
the balance sheet date. Revenues and expenses of foreign operations are
translated at the average exchange rates during the year. The effect of the
translation adjustments for foreign operations, net of applicable deferred
income taxes, is recorded as a cumulative translation adjustment in accumulated
other comprehensive income within stockholders' equity. Investments denominated
in foreign currencies are translated into the U.S. dollar using the rate of
exchange at the balance sheet date and unrealized gains and losses on
translation, net of applicable deferred income taxes, are recorded to other
comprehensive income. Foreign currency transaction gains and losses are included
in other income.
Accounting for Derivative Instruments and Hedging Activities
Effective January 1, 2001, Trenwick expects to adopt the new accounting
standard, "Accounting for Derivative Instruments and Hedging Activities," which
requires all derivatives to be recognized on the balance sheet at fair value.
The Company is currently reviewing the impact of the implementation of the
standard on its financial statements.
Note 2
Acquisitions
Chartwell Re Corporation
On October 27, 1999, Trenwick completed the merger of Chartwell Re Corporation
(Chartwell) with and into Trenwick. Under the terms of the merger, stockholders
of Chartwell received 0.825 Trenwick shares for each Chartwell share in a
tax-free transaction. Described below are the adjustments to record the assets
and liabilities at fair value and allocate the purchase price over fair value of
net assets acquired. All amounts are in thousands, except per share amounts.
Chartwell's outstanding common shares 9,655
Exchange ratio for the conversion of shares 0.825
Trenwick common shares issued in exchange for
Chartwell common shares 7,965
Trenwick's average price per common share $ 26.29
Total consideration for Chartwell's
common shares $209,400
Total consideration for Chartwell's
common stock options 3,632
Acquisition costs 18,294
Total purchase price $231,326
Less
Fair value of Chartwell's net assets 78,011
Goodwill $153,315
31
<PAGE>
The acquisition has been accounted for using the purchase method of accounting
and, accordingly, the purchase price has been allocated to the assets purchased
and the liabilities assumed based on the estimated fair values at the date of
acquisition. As a condition to the merger, Chartwell purchased, at the time of
the closing of the transaction, a reinsurance policy providing for up to
$100,000,000 in order to indemnify Trenwick against unanticipated increases in
Chartwell's reserves for business written on or before the date the merger was
completed. See Note 5 - Reinsurance. In connection with the acquisition of
Chartwell, the Company recognized a liability of approximately $4,700,000 for
anticipated severance costs of former Chartwell employees. The total amount paid
under the severance plan as of December 31, 1999 was approximately $4,300,000.
The excess of the purchase price over the estimated fair value of the net assets
of approximately $153,315,000 has been recorded as goodwill, which is being
amortized on a straight-line basis over 25 years. The purchase price has been
allocated based on a preliminary estimate of the fair value of net assets
acquired. All assets and liabilities of Chartwell are consolidated in the
balance sheet as of December 31, 1999 and its operating results are consolidated
in Trenwick's results commencing with the period from October 28, 1999 through
December 31, 1999.
The following unaudited pro forma consolidated results of operations for the
years ended December 31 assume the acquisition had occurred on January 1 of each
year:
1999 1998
(in thousands, except per share data)
Net premiums earned $ 478,226 $ 475,065
Total revenue 573,660 609,118
Net income (loss) (124,331) 59,697
Basic net income (loss) per share $ (6.76) $ 3.04
Diluted net income (loss) per share $ (6.76) $ 2.99
The above unaudited pro forma financial information is not necessarily
indicative either of the results of operations that would have occurred had this
transaction been consummated at the beginning of the periods presented or of
future results of operations.
LaSalle Re Holdings Limited
On December 19, 1999, Trenwick and LaSalle Re Holdings Limited (LaSalle Re)
signed a definitive agreement for Trenwick and LaSalle Re to combine, with
shareholders of both companies receiving shares in a new Bermuda holding company
to be named Trenwick Group Ltd. Under the terms of the business combination
agreement, shareholders of Trenwick and LaSalle Re will each receive shares in
the newly formed Trenwick on a one-for-one basis. The acquisition will be
accounted for as a purchase. Trenwick expects to close the transaction in the
second quarter of 2000, subject to shareholder and regulatory approvals and
other customary conditions.
32
<PAGE>
On March 20, 2000, Trenwick and LaSalle Re amended and restated the business
combination agreement in order to revise the portion of the business combination
agreement related to the restructuring of Trenwick immediately prior to the
combination with LaSalle Re.
Note 3
Investments
The following tables reconcile amortized cost to the estimated fair value of
debt and equity securities:
(in thousands) December 31, 1999
<TABLE>
<CAPTION>
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
<S> <C> <C> <C> <C>
U.S. Treasury securities and
obligations of U.S. government
corporations and agencies $ 114,839 $ 379 $ (681) $ 114,537
Obligations of states and
political subdivisions 460,176 2,221 (7,404) 454,993
Mortgage-backed and
asset-backed securities 290,801 1,263 (3,529) 288,535
Debt securities issued by
British government 117,165 110 (2,252) 115,023
Debt securities issued by other
foreign governments 55,436 44 (484) 54,996
Public utilities 21,229 43 (381) 20,891
Corporate securities 262,855 443 (3,852) 259,446
Certificates of deposit 2,937 3 - 2,940
Total debt securities $1,325,438 $ 4,506 $(18,583) $1,311,361
Equity securities $ 107,946 $ 7,752 $ (5,032) $ 110,666
</TABLE>
(in thousands) December 31, 1998
<TABLE>
<CAPTION>
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
<S> <C> <C> <C> <C>
U.S. Treasury securities and
obligations of U.S. government
corporations and agencies $ 64,831 $ 3,851 $ (14) $ 68,668
Obligations of states and
political subdivisions 380,593 13,544 (120) 394,017
Mortgage-backed and
asset-backed securities 206,790 8,648 (3,322) 212,116
Debt securities issued by
British government 45,949 587 - 46,536
Debt securities issued by other
foreign governments 8,163 78 - 8,241
Public utilities 2,864 222 - 3,086
Corporate securities 55,364 2,011 (65) 57,310
Redeemable preferred stock 2,000 48 - 2,048
Certificates of deposit 100,998 - - 100,998
Total debt securities $867,552 $28,989 $(3,521) $893,020
Equity securities $ 44,342 $ 6,514 $(1,668) $ 49,188
</TABLE>
33
<PAGE>
The fair value and amortized cost at December 31, 1999 are shown below by
contractual maturity periods for all debt securities except mortgage-backed and
asset-backed securities. Expected maturities will differ from contractual
maturities because borrowers may have the right to call or prepay obligations
with or without penalty. The maturities for mortgage-backed and asset-backed
securities are included in the table based on expected maturity dates.
Fair Amortized
(in thousands) Value Cost
---------- ----------
Due in one year or less $ 94,546 $ 93,913
Due after one year through
five years 544,077 545,161
Due after five years through
ten years 482,652 490,465
Due after ten years 190,086 195,899
Total debt securities $1,311,361 $1,325,438
Net Investment Income and Net Realized Investment Gains
During the twelve months ended December 31, 1999, all investments were income
producing. The sources of net investment income for the years ended December 31
are as follows:
(in thousands) 1999 1998 1997
------- ------- -------
Debt securities $61,964 $53,752 $47,400
Equity securities 2,442 1,744 1,257
Investments held by
managed syndicates 1,843 - -
Cash and cash
equivalents 1,666 2,470 1,228
Cash and cash
equivalents
held by managed
syndicates 644 - -
Other investments 177 - -
Gross investment income 68,736 57,966 49,885
Investment expenses (2,342) (1,650) (1,483)
Net investment income $66,394 $56,316 $48,402
Net realized gains (losses) on sales of investments are as follows:
(in thousands) 1999 1998 1997
Debt securities
Gross realized gains $ 3,147 $2,250 $ 151
Gross realized losses (6,797) (201) (146)
Equity securities
Gross realized gains 6,009 7,012 2,299
Gross realized losses (443) (45) -
Net realized
investment gains $ 1,916 $9,016 $2,304
Trenwick generally limits its investments in debt securities that are rated
below investment grade, as these investments are subject to a higher degree of
credit risk than investment grade securities. Trenwick closely monitors its
below investment grade securities as well as the creditworthiness of the
portfolio as a whole. When fair values decline for reasons other than changes in
interest rates or other perceived temporary conditions, the security is written
down to its net realizable value. In the twelve months ended December 31, 1999,
Trenwick wrote down the value of certain securities by $5,179,000.
34
<PAGE>
Unrealized Appreciation of Investments Available for Sale
The components of the net unrealized appreciation (depreciation) of investments
available for sale at December 31 are as follows:
(in thousands) 1999 1998
--------- ---------
Net unrealized appreciation
(depreciation) of debt
securities $(14,077) $ 25,468
Net unrealized appreciation
of equity securities 2,720 4,846
Net unrealized appreciation
(depreciation) of
investments (11,357) 30,314
Deferred tax benefit (expense) 3,907 (10,622)
Net unrealized appreciation
(depreciation) of
investments available
for sale, net of income taxes $ (7,450) $ 19,692
Investments and Cash Held as Collateral or on Deposit
Debt securities and cash with a carrying value of $127,026,000 are being held in
trust as collateral for certain reinsurance obligations. In addition, debt
securities and cash with a carrying value of $41,104,000 at December 31, 1999
were on deposit with various state or governmental insurance departments in
order to comply with insurance laws. Cash in the amount of $4,954,000 has also
been pledged as collateral for letters of credit for reinsurance obligations.
At December 31, 1999, the Company had cash of $5,040,000 held in a collateral
account in conjunction with a loan guarantee.
At December 31, 1999, the Company had loaned securities with carrying value of
approximately $16,155,000 at fair market value under a security lending
agreement administered through U.S. Bank. In connection with these transactions,
the Company holds as collateral cash or securities with a fair value equal to
102% of the fair value of the securities lent to others. Such collateral
securities are marked to market on a daily basis and borrowers are required to
supply additional collateral to prevent any collateral from falling below 102%
of the fair value of the loaned securities.
35
<PAGE>
Note 4
Unpaid Claims and Claims Expenses
The following table presents an analysis of gross and net unpaid claims and
claims expenses and a reconciliation of beginning and ending net unpaid claims
and claims expense balances. The gross unpaid claims and claims expense balances
at December 31, 1999 and 1998 are reflected in Trenwick's consolidated balance
sheet. The net unpaid claims and claims expense balances are stated on a net
basis after deductions for reinsurance recoverable on unpaid claims and claims
expenses from retrocessionaires.
<TABLE>
<CAPTION>
(in thousands) 1999 1998 1997
---- ---- ----
<S> <C> <C> <C>
Gross unpaid claims and claims expenses,
beginning of year $682,428 $518,387 $ 467,177
Reinsurance recoverable on unpaid claims and claims
expenses, beginning of year 233,164 139,036 80,290
Unpaid claims and claims expenses, net of
reinsurance recoverable, beginning of year 449,264 379,351 386,887
---------- --------- --------
Unpaid claims and claims expenses, net of
reinsurance recoverable, of companies acquired 808,466 81,299 -
---------- --------- ---------
Provision for claims and claims expenses, net of reinsurance recoverable:
For claims incurred in the current year 239,910 165,691 114,920
For claims incurred prior to the current year 14,628 (12,556) (5,366)
---------- --------- ----------
Subtotal 254,538 153,135 109,554
---------- --------- ----------
Payments for claims and claims expenses, net of reinsurance:
For claims incurred in the current year (65,856) (42,883) (22,893)
For claims incurred prior to the current year (230,493) (122,145) (94,197)
---------- --------- ----------
Subtotal (296,349) (165,028) (117,090)
---------- --------- ----------
Effect of exchange rate changes on unpaid claims
and claims expenses (8,483) 507 -
---------- --------- ----------
Unpaid claims and claims expenses, net of
reinsurance recoverable, end of year 1,207,436 449,264 379,351
---------- --------- ----------
Reinsurance recoverable on unpaid claims and
claims expenses, end of year 756,703 233,164 139,036
---------- --------- ----------
Gross unpaid claims and claims expenses,
end of year $1,964,139 $682,428 $518,387
========== ========= ===========
</TABLE>
In 1999, Trenwick recorded a gross increase of $83,175,000 and a net increase of
$14,628,000 in estimates for claims occurring in prior accident years, including
cessions of $46,460,000 to the Chartwell adverse development cover discussed in
Note 5. In 1998 and 1997, Trenwick recorded net decreases of $12,556,000 and
$5,366,000, respectively, in estimates for claims occurring in prior accident
years. The increase in 1999 is due to unfavorable development of prior year
reserves in Trenwick America Re. In 1999, Trenwick America Re's estimates of
prior accident year claims increased by approximately $25,402,000 on a gross
basis and $16,189,000 on a net basis. In 1998 and 1997, estimates of prior
accident year claims were reduced by approximately $7,175,000 and $5,366,000,
respectively. Trenwick America Re's increase in 1999 reflects a deterioration in
market conditions since 1997. In 1999 estimates of Trenwick International's
prior year claims increased by $11,313,000 on a gross basis and decreased by
$1,561,000 on a net basis. In 1998, Trenwick International's prior year claims
were reduced by approximately $5,381,000 on a net basis. The gross increase in
1999 was offset by the effect of reinsurance and favorable development across
certain lines of business.
36
<PAGE>
Inflation raises the cost of economic losses and non-economic damages covered by
insurance contracts and, therefore, is a factor in determining effective rates
of reinsurance. The methods used by Trenwick to estimate individual case
reserves and reserves for claims incurred but not yet reported implicitly
incorporate the effects of inflation in the projection of ultimate losses.
Due to the inherent uncertainties of estimating insurance company claim
reserves, actual claims and claims expenses may deviate, perhaps substantially,
from estimates of Trenwick's reserves reflected in Trenwick's consolidated
financial statements. Trenwick's management believes that its claim reserve
methods are reasonable and prudent and that Trenwick's reserve for claims and
claims expenses at December 31, 1999 are adequate. However, reserves also
include provisions for latent injury or toxic tort claims that cannot be
estimated with traditional reserving techniques. Due to inconsistent court
decisions' in federal and state jurisdictions and the wide variation among
insureds with respect to underlying facts and coverage, uncertainty exists with
respect to these claims as to liabilities of ceding companies and, consequently,
reinsurance coverage. With the exception of INSCORP, the Company's exposure to
such latent losses is not expected to be significant due to its relatively
recent entry into the reinsurance business, its low historical levels of premium
volume prior to the application of exclusions for asbestos and environmental
liabilities and its retrocessional programs. To the extent that there is adverse
development in INSCORP's loss reserves, including its reserves for latent
losses, the Company's obligation under the Contingent Interest Notes due June
30, 2006 (the CI Notes) will be reduced. To the extent the CI Notes do not
provide sufficient protection against adverse development in INSCORP's loss
reserves, Trenwick may be entitled to recoveries under the $100,000,000
reinsurance policy purchased by Chartwell immediately prior to its acquisition
by Trenwick. See Note 5-Reinsurance.
Trenwick's reserves include an estimate of Trenwick's ultimate liability for
asbestos and environmental claims. The gross and net unpaid claims and claims
expenses for asbestos and environmental claims are as follows:
(in thousands) 1999 1998 1997
---- ---- ----
Unpaid claims and claims expenses gross of
reinsurance recoverable, end of year $100,131 $8,476 $8,924
Unpaid claims and claims expenses, net of
reinsurance recoverable, end of year 72,092 8,428 8,814
Reinsurance recoverable on unpaid claims and
claims expenses, end of year 28,039 48 110
The increase of the gross and net unpaid claims and claims expenses reflects the
inclusion of the reserves related to the Chartwell acquisition.
37
<PAGE>
Note 5
Reinsurance
Trenwick enters into reinsurance and retrocessional agreements to reduce its net
liability on individual risks, protect against catastrophic losses and maintain
acceptable ratios.
Trenwick America Re has various retrocessional facilities, all of which are on a
treaty basis. These retrocessional facilities include one treaty for Trenwick
America Re's facultative casualty reinsurance business, which applies on a risk
or account basis, and two for its treaty property business, which protect it
against multiple claims arising out of a single occurrence or event. As a result
of these facilities, Trenwick America Re's maximum retention generally does not
exceed $500,000 per occurrence on facultative business and $2,300,000 per
occurrence on property catastrophe business. From 1989 to 1999, Trenwick America
Re has purchased aggregated excess of loss ratio treaties from several
reinsurers. These facilities provided Trenwick with a layer of protection
against adverse results from its domestic casualty business in excess of
specified loss ratios. Trenwick did not purchase an aggregate excess of loss
ratio treaty for 2000.
Trenwick International, as customary with companies operating in the London
market, buys large amounts of reinsurance. Reinsurance and retrocessional
coverage is customized for each class of business. During 1998, following an
increase in its share capital, Trenwick International increased its retention of
business by reducing the amount of reinsurance it buys, principally proportional
reinsurance treaties with its former parent.
Chartwell Managing Agency, as part of its business strategy, has historically
purchased a significant amount of reinsurance for the Lloyd's syndicates it
manages. Reinsurance is generally purchased to protect the syndicates against
extraordinary loss or loss involving one or more underwriting classes. The
amount purchased is determined with reference to the syndicates' aggregate
exposure and potential loss scenarios.
INSCORP and Dakota, the primary insurance subsidiaries of Canterbury Financial
Group, each purchases reinsurance specifically tailored to each of the specialty
programs which they underwrite.
Effective October 27, 1999, Chartwell purchased, at the time of the closing of
the transaction, a reinsurance policy providing for up to $100,000,000 in order
to indemnify Trenwick against unanticipated increases in Chartwell's reserves
for business written on or before the date the merger was completed. The Company
has applied the provisions of the Financial Accounting Standards Board's
Emerging Issues Task Force Topic D-54 to account for future adverse development
covered by the agreement. Recoverables under the agreement are presented gross
in the consolidated balance sheet as "Reinsurance recoverable balances." The
related benefit for losses ceded to the agreement is reflected as a reduction to
"Claims and claims expenses incurred" as discussed in Note 4. The benefit
related to other underwriting balances is reflected as a reduction to
"Underwriting expenses." In addition, as part of the merger, Chartwell commuted
several aggregate stop-loss contracts. Reinsurance agreements provide for
recovery of a portion of certain claims and claims expenses from reinsurers.
38
<PAGE>
Trenwick remains liable in the event that the reinsurer is unable to meet its
obligation; however, Trenwick holds partial collateral under these agreements.
The effects of reinsurance on premiums written and premiums earned for the three
years ended December 31, are as follows:
(in thousands) 1999 1998 1997
---- ---- ----
Direct premiums written $ 128,224 $ 60,510 $ -
Assumed premiums written 377,317 262,854 248,662
Ceded premiums written (150,931) (73,145) (53,432)
--------- ---------- ---------
Net premiums written $ 354,610 $ 250,219 $195,230
======== ========= =========
Direct premiums earned $ 84,542 $ 54,605 $ -
Assumed premiums earned 376,927 269,093 233,090
Ceded premiums earned (136,355) (78,137) (42,934)
--------- ---------- ---------
Net premiums earned $ 325,114 $ 245,561 $ 190,156
======== ======== =========
The Company recorded ceded claims and claims expenses incurred of $204,399,000,
$81,955,000 and $60,789,000 for the years ended December 31, 1999, 1998 and
1997, respectively.
The components of reinsurance recoverable balances, net on the balance sheet at
December 31 are as follows:
(in thousands) 1999 1998
---------- ---------
Paid claims $ 66,698 $ 17,098
Unpaid claims and claims expenses 756,703 233,164
Funds held liability (126,222) (86,614)
Reinsurance balances payable (52,601) (23,475)
---------- ----------
Reinsurance recoverable balances, net $ 644,578 $ 140,173
========== ==========
The funds held liability includes approximately $27,277,000 and $16,641,000 of
imputed interest as of December 31, 1999 and 1998, respectively. Approximately
$10,636,000, $7,009,000 and $4,989,000 of interest expense was incurred during
1999, 1998 and 1997, respectively, and recorded as a reduction to net earned
premiums.
Letters of credit, trust accounts and funds withheld in the aggregate amount of
$269,344,000 (including interest) have been arranged in favor of Trenwick
collateralizing reinsurance recoverables with respect to certain
retrocessionaires. At December 31, 1999, approximately 36% of Trenwick's
reinsurance recoverables on unpaid claims and claims expenses are recoverable
from five principal retrocessionaires. These retrocessionaires are Zurich
Reinsurance N.A, Continental Casualty Company, Centre Re-Insurance Ltd., London
Life and Casualty Reinsurance Corporation and UNUM Life Insurance Company of
America which had reinsurance recoverable balances of $148,854,000, $39,209,000,
$37,163,000, $24,391,000 and $22,363,000, respectively at December 31, 1999.
Such companies are rated A or better by A.M. Best Company.
Included in Deposits on the balance sheet at December 31, 1999 are $13,310,000
deposited with European International Reinsurance Limited and $6,917,000
deposited with Centre Reinsurance (Bermuda) Limited, both of which are secured
by letters of credit.
39
<PAGE>
For the years ended December 31, 1999, 1998 and 1997, Trenwick earned
commissions on cessions to retrocessionaires of $25,422,000, $10,495,000 and
$4,503,000, respectively.
Note 6
Income Taxes
Income taxes are established on a consolidated basis for all domestic and
international operations of Trenwick. In 1997, the income tax provision includes
an income tax benefit of $558,000 applicable to an extraordinary loss on debt
redemption. The components of the provision for income taxes for the years ended
December 31 are as follows:
(in thousands) 1999 1998 1997
-------- ------- --------
Current expense
(benefit)
Federal $(14,578) $4,392 $ 7,197
Foreign 1,515 2,324 -
State (44) 200 262
Total current
expense (benefit) $(13,107) $6,916 $ 7,459
Deferred expense
(benefit)
Federal $ 6,765 $1,110 $ 3,224
Foreign (3,830) 219 -
Total deferred expense 2,935 1,329 3,224
Total income tax expense
(benefit) $(10,172) $8,245 $10,683
Due to the carryback of current year's losses to previous years taxable income
including the Chartwell companies, the Company will recoup the maximum amount
refundable for taxes paid in the preceding two tax years.
The income tax provision for each of the years presented differs from the
amounts determined by applying the applicable U.S. statutory federal income tax
rate of 35% to income (loss) before income taxes as a result of the following:
(in thousands) 1999 1998 1997
-------- -------- --------
Income (loss) before
income taxes $(21,220) $43,037 $45,935
Income taxes at
statutory rate ($7,427) $15,063 $16,077
Effect of tax-exempt
investment income (6,227) (5,654) (5,757)
Foreign operations 903 (256) -
Amortization of
goodwill 498 - -
Valuation allowance 770 - -
Other, net 1,311 (908) 363
Income tax provision
(benefit) $(10,172) $8,245 $10,683
As of December 31, 1999, the Company and all includible subsidiaries have U.S.
net operating loss carryforwards of $53,195,000 which will be available (subject
to the annual limitation discussed below) to offset regular taxable income
during the carryforward period (expiring 2019). Of the total net operating loss
carryforward, $15,717,000 was generated by INSCORP prior to its acquisition in
1995 and is limited by Section 382 of the Internal Revenue Code, to an annual
amount of $3,483,000 to offset future taxable income each year.
40
<PAGE>
The Company provides income taxes on the undistributed earnings of non-U.S.
subsidiaries except to the extent that such earnings are considered permanently
reinvested outside the U.S. It is not practicable to determine the amount of
income or withholding tax that would be payable upon the remittance of those
earnings. However, the Company does not anticipate that the income or
withholding tax that would be payable upon remittance of the undistributed
earnings of the non-U.S. subsidiaries would aggregate to a material amount.
Deferred income tax assets (liabilities) are attributable to the following
temporary differences as of December 31:
(in thousands) 1999 1998
-------- --------
Deferred income tax asset
Discounting and other loss
reserve adjustments $ 30,647 $ 27,152
Unearned premium income 8,657 6,862
Net operating losses 18,618 -
Lloyd's loss reserve accrual 22,980 -
Contingent interest note 11,514 -
Tax basis difference
on portfolio securities 3,938 -
Employee stock option and
compensation plans 1,135 651
Foreign tax credit 7,722 -
Alternative minimum taxes 3,684 1,390
Currency translation
adjustments 1,603 197
Excess tax basis of
foreign subsidiaries 18,305 632
Foreign operations 6,207 -
Unrealized depreciation of
investments available
for sale 3,907 -
Other 2,206 -
Gross deferred income
tax assets 141,123 36,884
Less: Valuation allowance (23,982) -
Deferred tax assets after
valuation allowance 117,141 36,884
Deferred income tax liability
Policy acquisition costs
deferred (13,289) (10,716)
Unrealized appreciation of
investments available for sale - (10,622)
Earned but not reported
premiums net of loss
and expense (2,358) -
Accretion of market
discount on debt securities (1,416) (1,282)
Equity investment adjustments (1,102) -
Other (1,534) (163)
Gross deferred income
tax liabilities (19,699) (22,783)
Net deferred income tax assets $ 97,442 $ 14,101
41
<PAGE>
During 1999, the Company recorded a valuation allowance of $23,982,000 to reduce
its deferred tax asset in accordance with the provisions of the accounting
standard "Accounting For Income Taxes" (FASB 109). The valuation allowance is
necessary because sufficient uncertainty exists regarding the realizability of
certain foreign tax credits and other deferred tax assets related to the excess
tax basis of foreign subsidiaries. The Company will periodically review the
adequacy of the valuation allowance and will recognize benefits only as the
reassessment indicates that it is "more likely than not" that these benefits
will be realized. In accordance with the provisions of FASB 109, any reduction
in the valuation allowance will be offset against goodwill. Realization of the
related tax benefits will depend upon the recognition of future earnings from
foreign operations or a change in circumstances that cause the recognition of
these benefits to meet the "more likely than not" standard of FASB 109.
Note 7
Long-Term Debt
Senior Notes
On March 27, 1998 Trenwick completed a private offering of $75,000,000 aggregate
principal amount of its 6.70% Senior Notes due April 1, 2003 (the Senior Notes).
Interest is payable semi-annually on April 1 and October 1 of each year, which
commenced on October 1, 1998. The Senior Notes are not subject to redemption
prior to maturity. They are unsecured obligations and will rank senior in right
of payment to all existing and future subordinated indebtedness of Trenwick,
including Trenwick's obligations with respect to its 8.82% Junior Subordinated
Debentures held by Trenwick Capital Trust I in respect of the $110,000,000 in
8.82% Subordinated Capital Income Securities issued by the Trust. Under the
terms of the Senior Notes, Trenwick is not restricted from incurring
indebtedness, but is subject to limits on its ability to incur secured
indebtedness for borrowed money.
On March 17, 1994, Chartwell completed a public offering of 10.25% Senior Notes
due 2004, having a total principal amount of $75,000,000. On December 13, 1995,
the obligations were assumed by Chartwell Re Holdings Corporation (Chartwell Re
Holdings). Of the original balance, Chartwell Re Holdings redeemed $26,250,000
on April 8, 1996 and repurchased $8,675,000 on November 24, 1999.
Mandatorily Redeemable Preferred Capital Securities
On January 28, 1997, Trenwick completed a private offering of $110,000,000 in
8.82% Subordinated Capital Income Securities through Trenwick Capital Trust I, a
Delaware statutory business trust. Trenwick owns all of the common securities of
the trust. Concurrently with the issuance of the capital securities, the trust
invested the proceeds of their sale, together with the consideration paid to the
trust by Trenwick for the common securities, in Trenwick's junior subordinated
debentures, whose terms are similar to those of the capital securities.
42
<PAGE>
The trust was formed for the sole purpose of issuing the capital securities and
the common securities, investing the proceeds thereof in the junior subordinated
debentures and making distributions to the holders of the capital securities.
The capital securities mature on February 1, 2037; require preferential
cumulative cash distributions at an annual rate of 8.82%, payable semi-annually
on February 1 and August 1 (beginning August 1, 1997) from the payment of
interest on the junior subordinated debentures; and are guaranteed by Trenwick,
within certain limits, as to the payment of distributions and liquidation or
redemption payments. They are subject to mandatory redemption; (i) in whole but
not in part at maturity, upon repayment of the junior subordinated debentures,
at a redemption price equal to the greater of the principal amount plus accrued
and unpaid interest; (ii) in whole but not in part at any time,
contemporaneously with the optional prepayment of the junior subordinated
debentures upon the occurrence and continuation of certain events, at a
redemption price equal to the greater of the principal amount or the present
value of principal and interest payable to February 1, 2007, plus accrued and
unpaid interest and possible additional sums; and (iii) in whole or in part,
after February 1, 2007, contemporaneously with the optional prepayment of the
junior subordinated debentures, at a redemption price equal to the principal
amount plus accrued and unpaid interest and possible additional sums. Upon the
occurrence and continuation of an event of default with respect to the junior
subordinated debentures, the capital securities shall have a preference over the
common securities. Upon the occurrence of an event of default with respect to
the junior subordinated debentures which is attributable to Trenwick's failure
to make required payments or with respect to Trenwick's guarantee, the holders
of the capital securities may institute a direct action against Trenwick. In
accordance with their terms, the capital securities were subsequently exchanged
for fully registered capital securities, which are not subject to restrictions
on transfer.
Convertible Debentures
On February 20, 1997, Trenwick called for redemption all $103,500,000 aggregate
principal amount of Trenwick's 6% convertible debentures due December 15, 1999,
at a redemption price of 102.57% principal amount plus accrued interest to the
redemption date. Of the $103,500,000 principal amount of debentures outstanding
on that date, $45,819,000 principal amount were redeemed and $57,681,000
principal amount were converted into an aggregate of 1,783,926 shares of
Trenwick's common stock.
As a result of the redemption, Trenwick recorded an extraordinary loss of
$1,037,000 net of a tax benefit of $558,000 in 1997.
Senior Credit Facilities
On November 24, 1999, Trenwick entered into a $400,000,000 credit agreement with
various lending institutions, The Chase Manhattan Bank, as Administrative Agent,
First Union National Bank, as Syndication Agent, and Fleet National Bank, as
Documentation Agent. This new credit facility provides for a $170,000,000, 364
day revolving credit facility with an option to pay out outstanding borrowings
under such facility over the four years following the expiration of the 364 day
period. In addition, the credit facility provides for a $230,000,000 five year,
Lloyd's letter of credit facility, with a one year automatic renewal option. The
applicable interest rate on borrowings under the credit facility is currently
1.3% above the London Interbank Offered Rate or The Chase Manhattan Bank prime
commercial lending rate. A commitment fee is charged on the unutilized portion
of the facility and is currently at .25%. At the end of the revolving period,
all outstanding revolving loans will, at the option of Trenwick, convert to a
four-year term loan facility, subject to scheduled principal amortization over
the four-year period. As of December 31, 1999, Trenwick has approximately
$94,501,000 of revolving loans outstanding, the proceeds of which were used to
retire Chartwell Re Holdings' syndicated debt facility with First Union,
repurchase Trenwick common shares, and redeem a portion of the Chartwell Re
Holdings senior debt. The Letter of Credit Facility of $230,000,000 is available
in U.S. Dollars or Pounds Sterling and shall only be issued for the account of
Lloyd's to support Trenwick's syndicate participations. The unsecured letters of
credit are in force for five years and will automatically renew for one
additional year on the anniversary of the November closing date. The Applicable
Margin is charged on an annual basis on the utilized portion of the facility,
which is currently $208,000,000. A commitment fee, which is currently .25%, is
charged on the unused portion of the Letter of Credit Facility.
43
<PAGE>
The Chase Credit Facility contain general covenants and restrictions as well as
financial covenants relating to, among other things, minimum interest coverage,
debt to capital leverage, minimum earned surplus and tangible net worth.
Trenwick and the banks party to the credit facility executed an amendment to the
credit facility, dated as of December 31, 1999, reducing the required minimum
consolidated tangible net worth of Trenwick from $325,000,000 to $290,000,000
until June 30, 2000. After giving effect to the amendment, as of December 31,
1999, the Company is in compliance with the covenants.
Contingent Interest Notes
In conjunction with the 1999 acquisition of Chartwell, the Company assumed all
of the obligations under the CI Notes, which were originally issued by Piedmont
Management Company Inc. (Piedmont), INSCORP's former parent, to its stockholders
just prior to its acquisition by Chartwell in 1995. The CI Notes were issued
immediately prior to Chartwell's acquisition of Piedmont to protect Chartwell
against the possibility of adverse development of INSCORP's reserves for losses
and loss adjustment expenses and long-tail casualty exposures. The CI Notes were
issued in an aggregate principal amount of $1,000,000, with principal accruing
interest at a rate of 8% per annum, compounded annually. Such interest will not
be payable until maturity or earlier redemption of the CI Notes. In addition,
the CI Notes will entitle the holders thereof to receive at maturity, in
proportion to the principal amount of the CI Notes held by them, an aggregate of
from $10,000,000 up to $55,000,000 in contingent interest. Settlement of the CI
Notes may be made by payment of cash or, at the Company's election, by delivery
of shares of the Company's common stock. In order for the CI Notes to be settled
in common stock of the Company, the Company's common stock must be registered
under the Securities Act of 1933 and listed on a national securities exchange or
the NASDAQ National Market. For purposes of any settlement of the CI Notes in
the Company's common stock, the value ascribed to each share of common stock
shall be 85% of the average of the closing sales prices of the common stock for
the 20 trading days immediately preceding the fifth trading day prior to the
settlement date. The CI Notes mature on June 30, 2006. At December 31, 1999, the
CI Notes are recorded at the present value of the amount which is reasonably
determined to be payable at maturity. The Company believes that INSCORP's
reserves for loss and loss adjustment expenses are an appropriate estimate of
projected ultimate losses and loss adjustment expenses to be paid and therefore,
at this time, the maximum amount of contingent interest on the CI Notes is
presently expected to be paid at maturity. The CI Notes contain covenants, which
relate to the maintenance of certain records and limitations on certain
indebtedness. As of December 31, 1999 the Company is in compliance with those
covenants.
Future minimum payments on long term debt as of December 31, 1999 are as follows
(in thousands):
1999
-------
2000 $94,501
2002 4,874
2003 75,000
2004 40,075
2006 34,699
------
$249,149
44
<PAGE>
Note 8
Commitments and
Contingencies
Letters of Credit
At December 31, 1999, Trenwick has outstanding standby letters of credit
totaling $208,000,000 as part of the senior credit facilities supporting CMA
syndicate participations. Additionally, INSCORP has a $3,100,000 letter of
credit to support the participation in Riverside Underwriters, plc. Both of
these standby letters of credit are in force for five years, and provide capital
to participate in certain Lloyd's syndicates for the 1996 to 2000 underwriting
years of account.
Lloyd's syndicate 839 has a letter of credit facility for $21,400,000, which is
secured by its Sterling Premium Trust Fund. This letter of credit is deposited
in the United States Surplus Lines Trust Fund.
Letters of credit are also provided to support domestic and international
reinsurance operations, totaling approximately $2,700,000.
Lines of Credit
Trenwick International has established a line of credit under which it can
borrow up to $1,618,000 at a rate of 2.5% above the lending bank's base rate.
Chartwell UK also has established a line of credit under which it can borrow up
to $1,618,000 at a rate of 1% above the lending bank's base rate. These lines of
credit are available in the event that funds are required to supplement
short-term working capital. There were no material borrowings under either line
of credit during 1999.
Lloyd's syndicates 270, 741 and 2741 have separate lines of credit of
$7,000,000, $1,780,000 and $485,000 respectively. There were no material
borrowings under these lines of credit during 1999.
Limited Partnership Investment
Chartwell Reinsurance has committed to invest $15,000,000 in a private equity
fund, High Ridge Capital Limited Partnership, which makes investments in the
insurance industry. The Company contributed a total of $13,300,000 to this fund
as of December 31, 1999.
Operating Lease Agreements
Trenwick leases office space under non-cancelable operating leases which expire
at various dates through 2015. Trenwick's future minimum lease commitments as of
December 31, 1999 are as follows:
2000 $ 5,659,633
2001 5,250,608
2002 5,139,674
2003 5,303,349
2004 5,453,766
2005 and thereafter 19,870,082
Total office rent expense for the years ended December 31, 1999, 1998 and 1997
is $3,024,000, $2,042,000 and $917,000, respectively.
45
<PAGE>
Litigation
The Company is party to various legal proceedings generally arising in the
normal course of its business. The Company does not believe that the eventual
outcome of any such proceeding will have a material effect on its financial
condition or results of operations or cash flows. The Company's subsidiaries are
regularly engaged in the investigation and the defense of claims arising out of
the conduct of their business. Pursuant to the Company's insurance and
reinsurance arrangements, disputes are generally required to be finally settled
by arbitration.
Note 9
Stockholders'
Equity
Preferred Stock
Trenwick has 2,000,000 shares of $.10 par value preferred stock authorized and
none outstanding.
Common Stock
During the year, Trenwick's Board of Directors approved an additional 3,000,000
shares to its stock repurchase program for a total of 4,600,000 shares. The
program was originally adopted on May 21, 1997. During 1999, 2,176,200 shares
were repurchased at an average price of $21.42 per share.
Between January 1, 2000 and March 30, 2000, Trenwick has purchased 829,300
shares under its buyback plan, at an average price of $16.56 per share. Trenwick
has an authorization of 494,000 shares remaining under the plan.
Stockholder Rights Plan
During 1997, Trenwick adopted a new stockholder rights plan, replacing the plan
adopted in 1989, and redeemed the rights issued under the 1989 plan.
Stockholders of record at the close of business on September 24, 1997 received
$0.01 for each redeemed right (equivalent to $0.00667 per share) and received
one new right for each share of common stock held. The rights are exercisable
only if a person or group acquires beneficial ownership of 15% or more of
Trenwick's common stock or commences a tender or exchange offer upon
consummation of which such person or group would beneficially own 15% or more of
Trenwick's common stock. Each right entitles a stockholder to buy 1/200 of a
share of Trenwick's Series B Junior Participating Preferred Stock at an exercise
price of $125, subject to adjustment. Trenwick has reserved 200,000 shares of
such preferred stock for possible issuance under the plan.
In the event that an acquirer accumulates 15% or more of Trenwick's common
stock, all rights holders except the acquirer may purchase, for the exercise
price, in lieu of the Series B Junior Participating Preferred Stock, shares of
common stock of Trenwick having a market value of twice the exercise price of
each right. If Trenwick is acquired in a merger or other business combination
after the acquisition of 15% of Trenwick's common stock, all rights holders
except the acquirer may purchase the acquirer's shares at a similar discount.
Trenwick is entitled to redeem the rights at $0.01 per right, subject to certain
restrictions. The rights will expire on September 23, 2007.
46
<PAGE>
Note 10
Employee Benefits
and Compensation
Arrangements
Retirement Plans
Trenwick has a defined contribution plan and a 401(k) savings plan for
substantially all U.S. full-time employees. Trenwick contributes 8% of an
eligible employee's total compensation to the pension plan; no employee
contributions are made to the plan. Trenwick matches 100% of employees'
contributions to the savings plan up to 6% of each eligible employee's total
compensation. Assets of both plans are administered by life insurance companies.
Trenwick's contributions to the pension plan were $429,000, $463,000 and
$503,000 for 1999, 1998 and 1997, respectively; its contributions to the savings
plan were $365,000, $351,000 and $330,000 for 1999, 1998 and 1997, respectively.
A member of management will receive a supplemental employee benefit payable at
the earlier of age 65 or employment termination. The supplement will be equal to
the aggregate contributions made with respect to the employee to a trust
established by the company. Annual contribution to the trust is 13.5% of the
employee's base salary as stated in the employment agreement. The amount
expensed in 1999 for this employee benefit obligation is not material.
Trenwick also maintains a money purchase defined contribution pension plan
covering substantially all Trenwick International employees. Contributions under
this plan are determined on the basis of salary and age. Trenwick's contribution
to this plan in 1999 and 1998 was $1,427,000 and $997,000, respectively.
Chartwell U.K. operates contributory defined contribution plans for its U.K.
employees. The level of the contribution varies between 5% and 20% dependent
upon the age of each participant at the beginning of each calendar year. The
amount expensed in 1999 for the obligation under these plans amounted to
$435,000.
The defined contribution plan for Chartwell's U.S. employees was terminated
immediately prior to the consummation of the merger of Chartwell into Trenwick.
As a result, certain former Chartwell employees became members of the Company's
plan and, in certain instances, the assets held by those employees in
Chartwell's plans were transferred to the Company's plans.
Stock Options and Common Stock Warrants
Trenwick has several plans through which it makes options in common stock
available to Trenwick employees at the discretion of the Board of Directors.
Non-employee directors receive automatic grants under a separate plan. Exercise
prices are generally fixed at the market value at the date of grant. Options
vest and are exercisable on various terms, usually either over a five year
period or up to a ten year period. All options have an expiration date not
exceeding ten years. Total authorized common stock reserved for future issuance
under all stock benefit plans at December 31, 1999 is 1,827,527 shares.
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<PAGE>
Transactions under the stock option plans during 1999, 1998 and 1997 are
summarized as follows:
1999 1998 1997
-------- ------- --------
Number of options
Outstanding, beginning
of year 907,210 911,195 981,195
Issued in exchange for
Chartwell options 1,160,182 - -
Granted 175,960 124,210 8,250
Cancelled (46,029) (6,000) (1,500)
Exercised - (122,195) (76,750)
Outstanding,
end of year 2,197,323 907,210 911,195
Exercisable,
end of year 1,387,789 210,112 312,807
Average exercise price
Issued in exchange for
Chartwell options $30.57 - -
Granted 28.34 $36.72 $32.88
Cancelled 29.41 29.70 30.92
Exercised - 12.57 12.46
Outstanding,
end of year 29.80 29.07 25.82
Exercisable,
end of year 30.30 27.87 21.81
Included in the table above are options granted to certain senior officers under
the 1993 Stock Option Plan. The exercise and vesting of these options are
accelerated if the price of Trenwick's common stock achieves certain specified
levels, subject to certain conditions.
At the time of Trenwick's acquisition of Chartwell, all of the options issued
under Chartwell's stock option plans became fully vested.
At December 31, 1999, there were warrants outstanding which were issued in
exchange for Chartwell warrants upon consummation of the acquisition for the
purchase of 275,989 shares of common stock at an average price of $25.45 per
share.
Pro Forma Information
Trenwick applies the provisions of Accounting Principles Board Opinion
"Accounting for Stock Issued to Employees," and related interpretations in
accounting for its stock-based compensation plans. Since stock options under
Trenwick's plans are issued at fair market value on the date of grant, no
compensation expense has been recognized for these stock options or warrants.
Had Trenwick applied the fair value based method, net income and net income per
share would have been the pro forma amounts indicated below (in thousands,
except per share data):
1999 1998 1997
---- ---- ----
Net income (loss)
As reported $(11,048) $34,792 $35,252
Pro forma (11,393) 34,850 35,083
Basic earnings (loss) per share
As reported $(.94) $2.99 $3.03
Pro forma (.97) 2.97 $3.01
48
<PAGE>
The pro forma adjustments relate to options granted from 1995 to 1999 for which
a fair value on the date of grant was determined using the Black-Scholes option
pricing model. No effect has been given to options and warrants granted prior to
1995. Valuation and related assumption information are presented below:
1999 1998 1997
---- ---- ----
Valuation Assumptions:
Expected volatility
Employees 28% 23% -
Non-employee directors 28% 23% 27%
Non-employee directors
(former Chartwell) 27% - -
Risk-free interest rate
Employees 6.1% 5.6% -
Non-employee directors 6.1% 5.6% 6.1%
Non-employee directors
(former Chartwell) 6.1% - -
Dividend Yield 3.0% 3.1% 2.6%
The Black-Scholes option valuation model was developed for use in estimating the
fair value of options which have no vesting restrictions and are fully
transferable. In addition, option valuation models require the input of highly
subjective assumptions including the expected stock price volatility. Because
Trenwick's stock options have characteristics significantly different from those
of traded options, and because changes in the subjective input assumptions can
materially affect the fair value estimate, in management's opinion, the existing
models do not necessarily provide a reliable single measure of the fair value of
its stock options.
Restricted Common Stock Awards
Trenwick awards restricted common stock to key employees, under the terms of the
1989 and 1993 Stock Plans. In 1999, 65,985 shares were awarded at an average
price of $29.00 per share (approximately $1,914,000), which vest over five
years. Shares awarded in 1998 and 1997 vest over five years. Shares were
repurchased in 1999, 1998 and 1997 in connection with the satisfaction of
employees' withholding taxes payable upon the vesting of previously awarded
shares. During 1999, 8,369 shares were repurchased at an average price of $31.54
per share (approximately $264,000). Trenwick has recognized compensation expense
of $982,000, $770,000 and $543,000 for 1999, 1998 and 1997, respectively,
determined by the award value of the shares amortized over the applicable
vesting period.
49
<PAGE>
Note 11
Comprehensive
Income
The components of accumulated other comprehensive income at December 31 are as
follows:
(in thousands) 1999 1998
----- -----
Unrealized investment
gains (losses) $(9,464) $ 39,330
Realized investment gains
included in net income (1,916) (9,016)
Foreign currency
translation adjustment (3,854) (552)
Deferred income tax (benefit)
expense 5,509 (10,425)
Accumulated other
comprehensive income (loss) $(9,725) $ 19,337
The income tax benefit (expense) applicable to each component of other
comprehensive income are as follows:
(in thousands) 1999 1998 1997
----- ---- -----
Unrealized investment
gains (losses) $13,880 $(2,810) $(3,750)
Realized investment
gains (losses)
included in
net income 649 3,091 (806)
Foreign currency
translation
adjustment 1,406 197 -
Income tax benefit
(expense) applicable
to other comprehensive
income (loss) $15,935 $ 478 $(4,556)
50
<PAGE>
Note 12
Insurance
Regulation
Trenwick America Re, Chartwell Reinsurance, INSCORP, ReCor Insurance Company
(ReCor) and Dakota Specialty Insurance Company (Dakota) are subject to the
insurance laws and regulations of their respective domiciliary state insurance
departments which were, as of December 31, 1999, Connecticut, Minnesota, New
York, New York and North Dakota, respectively. Effective January 1, 2001, the
Connecticut, Minnesota, New York and North Dakota Insurance Departments will
adopt the Codification of Statutory Accounting Principles (the Codification).
The Codification provides guidance for areas where statutory accounting has been
silent and changes current statutory accounting in some areas. The Company has
not finalized the quantification of the effects of Codification on its statutory
financial statements.
Under the holding company structure, Trenwick is dependent upon the ability of
its operating subsidiaries for the transfer of funds principally in the form of
cash dividends and tax reimbursements.
Under the applicable provisions of the insurance holding company laws of
Connecticut, Minnesota and North Dakota, insurance companies may only pay
dividends without the approval of the applicable state insurance regulator, if
such dividends, together with other dividends paid within the preceding twelve
months, are less than the greater of (i) 10% of the insurer's policyholders'
surplus as of the end of the prior calendar year or (ii) the insurer's statutory
net income, excluding realized capital gains, for the prior calendar year. As a
further restriction, the maximum amount of dividends insurers may pay is limited
to its earned surplus, also known as its unassigned funds. Any dividend in
excess of the amount determined pursuant to the foregoing formula would be
characterized as an "extraordinary dividend" requiring the prior approval of the
state insurance regulator.
51
<PAGE>
Under New York law, which is applicable to INSCORP and ReCor, the maximum
ordinary dividend payable in any twelve month period without the approval of the
New York Insurance Department is the lesser of (i) 10% of policyholders' surplus
as shown on the company's last annual statement or any more recent quarterly
statement or (ii) the company's adjusted net investment income. Adjusted net
investment income is defined as net investment income for the twelve months
preceding the declaration of the dividend plus the excess, if any, of net
investment income over dividends declared or distributed during the period
commencing thirty-six months prior to the declaration or distribution of the
current dividend and ending twelve months prior thereto. In any case, New York
law permits the payment of an ordinary dividend by an insurer or reinsurer only
out of earned surplus.
In addition to the foregoing limitations, the New York Insurance Department, as
is its practice in any change of control situation, required Trenwick to commit
to preclude the acquired New York-domiciled insurers, INSCORP and ReCor, from
paying any dividends for two years after the merger with Chartwell without prior
regulatory approval. The foregoing restriction will expire on October 27, 2001.
Neither INSCORP nor ReCor paid any dividends in 1997, 1998 or 1999.
In 2000, of Trenwick's U.S. insurance subsidiaries, only Dakota could pay a
dividend or other distribution without prior approval of the applicable
insurance regulatory authority. In 2000, Dakota could pay a dividend of
$2,800,000 without prior approval. During 1999, 1998 and 1997, Trenwick America
Re paid dividends of $53,400,000, $30,100,000 and $8,300,000, respectively.
Chartwell Reinsurance paid dividends of $30,300,000 in 1999 and $3,000,000 in
1997. Chartwell Reinsurance did not pay any dividends in 1998. None of
Trenwick's other U.S. insurance subsidiaries paid any dividends in 1999, 1998 or
1997.
Under the applicable laws of the United Kingdom, Trenwick's U.K. subsidiaries
may make distributions only from accumulated realized profits, net of
accumulated realized losses. In addition, under the U.K. Insurance Companies
Act, Trenwick International is not permitted to make any distribution that would
reduce its net assets below the required minimum margin of solvency which, as
determined under the U.K. Financial Services Authority's rules, is approximately
$16,700,000 as of December 31, 1999. In addition, Trenwick International must
also notify the U.K. Financial Services Authority of any proposal to declare or
pay a dividend on any of its share capital. Under Lloyd's regulations, Chartwell
Managing Agents is not permitted to make any distribution that would cause its
assets to fall below any of Chartwell Managing Agents' share capital, minimum
net current asset margin or minimum net asset margin. As of December 31, 1999,
the highest of the three tests required Chartwell Managing Agents to maintain
approximately $1,100,000 of capital.
Trenwick Group Inc.'s reinsurance and insurance subsidiaries file financial
statements prepared in accordance with statutory accounting practices prescribed
or permitted by insurance regulators of their respective state of domicile.
Combined net income and statutory surplus of Trenwick Group Inc. were as
follows:
(in thousands) 1999 1998 1997
--------- -------- -------
Net income (loss) $(53,270) $ 40,930 $42,797
Statutory surplus 458,824 330,496 -
52
<PAGE>
The NAIC's model risk-based capital regulation (the RBC Model Act) requires
insurance companies to calculate and report information under a risk-based
capital formula which measures statutory capital and surplus needs based on the
risks in a company's mix of business and investment portfolio. Based on its
calculation as of December 31, 1999, Trenwick America Re, Chartwell Reinsurance,
INSCORP, ReCor and Dakota each exceeds all of the capital levels prescribed in
the RBC Model Act.
Note 13
Supplemental
Cash Flows
Information
A reconciliation of cash provided by (used for) operations for the three years
ended December 31 is as follows:
(in thousands) 1999 1998 1997
-------- -------- --------
Net income (loss) $(11,048) $34,792 $ 35,252
Adjustments to reconcile
net income (loss) to
net cash provided by
(used for) operating
activities
Equity in net earnings
of investees (188) - -
Contingent interest 642 - -
Amortization of premiums
on investments, net 1,832 4,219 2,557
Deferred income taxes 2,935 1,329 3,224
Net realized investment
gains (1,916) (9,016) (2,304)
Depreciation expense 1,942 998 371
Amortization of debt
issuance costs 292 124 32
Extraordinary loss on
debt redemption - - 1,595
Amortization expense 1,423 - -
Other 1,013 908 558
Change in assets and
liabilities, net of
effects from purchase
of subsidiary
Premiums in process of
collection 8,906 2,543 (29,178)
Deferred policy
acquisition costs (6,655) (679) (719)
Current income taxes
receivable/payable (24,748) 1,865 (1,759)
Other assets 109 (1,270) (5,268)
Unpaid claims and claims
expenses, net of
reinsurance
recoverable balances (10,142) (3,638) 32,621
Unearned premium income,
net of prepaid
reinsurance premiums 27,393 3,552 5,073
Other liabilities (44,088) 2,142 4,955
Net cash provided by
(used for) operating
activities $(52,298) $37,869 $ 47,010
53
<PAGE>
Note 14
Fair Value of
Financial
Instruments
The fair value of a financial instrument is defined as the amount at which the
instrument could be exchanged in a current transaction between willing parties.
In the event that quoted market prices were not available, fair values were
based on estimates using discounted cash or other valuation techniques. Those
techniques are significantly affected by the assumptions used, including the
discount rates and estimates of the amount and timing of future cash flows.
Accrued premiums have estimated payment dates ranging from 1999 to 2003. Premium
payment dates are estimated using the anticipated payout pattern of claims which
result in the additional premium due from ceding companies. The fair value is
estimated using cash flows discounted at an interest rate of 5%. These fair
value estimates may vary in the near term.
The following table presents in summary form the carrying amounts and estimated
fair values of Trenwick's financial instruments at December 31:
<TABLE>
<CAPTION>
(in thousands) 1999 1998
------ ------
Carrying Fair Carrying Fair
Amount Value Amount Value
--------- ------- --------- ------
<S> <C> <C> <C> <C>
Assets
Debt securities $1,311,361 $1,311,361 $893,020 $893,020
Equity securities 110,666 110,666 49,188 49,188
Other investments 19,446 19,446 - -
Investments held by
managed syndicates 137,745 137,745 - -
Cash and cash equivalents 125,954 125,954 63,003 63,003
Cash and cash equivalents held
by managed syndicates 44,687 44,687 - -
Accrued premiums 279,480 276,474 126,758 124,832
Deposits 20,227 20,227 - -
Liabilities
6.70% senior notes due 2003 $ 75,000 $ 74,153 $ 75,000 $ 78,750
10.25% senior notes due 2004 39,831 42,778 - -
7.67% senior credit facility
due 2000 80,000 81,801 - -
6.94% senior credit
facility due 2000 14,501 14,723 - -
Contingent interest notes 34,699 34,699 - -
Other long-term debt 4,874 4,638 - -
Company-obligated mandatorily redeemable
preferred capital securities of subsidiary
trust holding solely junior subordinated
debentures of Trenwick Group Inc. $ 110,000 $ 91,982 $110,000 $110,150
</TABLE>
54
<PAGE>
Note 15
Related-Party
Transactions
The Company holds an equity investment in certain managing general agents (MGAs)
through which it writes primary insurance business. Such investments are
accounted for under the equity method. At December 31, 1999, the carrying value
of the investments in Florida Intracoastal Underwriters (25% owned), HDR
Insurance Services (20% owned), Cambridge Alliance (35% owned) and Inter-Reco,
Inc. (49% owned) were $1,148,000, $654,000, $211,000 and $204,000, respectively.
For the year ended December 31, 1999, the Company incurred $6,238,000 of
commission expense payable to these MGAs. At December 31, 1999, the Company's
balance sheet includes $28,740,000 of agents' balances receivable from these
MGAs including installment premiums deferred and not yet due. The current
portion of balances due from these MGAs are settled on a monthly basis.
Note 16
Earnings
Per Share
The following table sets forth the computation of basic and diluted earnings per
share:
(in thousands except per share data) 1999 1998 1997
-------- -------- --------
Income (loss) available to
common stockholders
Income (loss) before extraordinary
item (basic) $(11,048) $34,792 $36,289
Add interest on
convertible debentures,
net of income taxes - - 578
Income (loss) before extraordinary
item (diluted) $(11,048) $34,792 $36,867
Net income (loss) (basic) $(11,048) $34,792 $35,252
Add interest on convertible debentures
and loss on debt redemption, net of
income taxes - - 1,615
Net income (loss) (diluted) $(11,048) $34,792 $36,867
Weighted average shares of common
stock outstanding
Weighted average shares outstanding
(basic) 11,762 11,657 11,645
Weighted average shares issuable on
exercise of employee stock options and
stock warrants net of assumed repurchases - 122 173
Weighted average shares issuable on
conversion of debt - - 447
Weighted average shares outstanding
(diluted) 11,762 11,779 12,265
Basic earnings (loss) per share
Income (loss) before extraordinary item $(.94) $2.99 $3.12
Net income (loss) $(.94) $2.99 $3.03
Diluted earnings (loss) per share
Income (loss) before extraordinary item $(.94) $2.95 $3.01
Net income (loss) $(.94) $2.95 $3.01
55
<PAGE>
Note 17
Segment
Information
In 1998, Trenwick adopted the accounting standard "Disclosures about Segments of
an Enterprise and Related Information." This statement requires reporting of
information utilizing a management approach. This approach designates the
internal organization that is used by management for making operating decisions
and assessing performance as the source of the Company's reportable segments.
This statement also requires disclosures about products and services, geographic
areas and major customers. The adoption of this statement did not affect the
results of operations or financial position.
Trenwick has determined that its reportable segments are those that are based on
the Company's method of internal reporting, which segregates its business by
geographic location. Trenwick has four reportable business segments: (1)
Trenwick America Re, (2) Canterbury Financial Group Inc. (3) Trenwick
International and (4) CMA. Trenwick America Re underwrites treaty reinsurance of
property and casualty risks primarily written by U.S. insurance companies.
Trenwick America Re includes reinsurance business of Chartwell Reinsurance and
its subsidiaries since its acquisition on October 27, 1999. Canterbury Financial
Group underwrites specialty insurance in the United States. Trenwick
International provides specialty insurance and treaty and facultative
reinsurance on a world-wide basis. CMA manages Trenwick's participation in the
Lloyd's market.
56
<PAGE>
The summary financial results for Trenwick's operating segments for the year
ended December 31, are as follows:
<TABLE>
<CAPTION>
(in thousands) 1999 1998 1997
-------- -------- --------
<S> <C> <C> <C> <C>
Net premiums earned Trenwick America Re $166,906 $174,443 $190,156
Canterbury Financial Group 10,343 - -
Trenwick International 107,911 71,118 -
Chartwell Managing Agents 39,954 - -
325,114 245,561 190,156
Net investment Trenwick America Re 49,315 44,490 43,692
income Canterbury Financial Group 1,722 - -
Trenwick International 11,253 10,614 -
Chartwell Managing Agents 3,845 - -
Unallocated 259 1,212 4,710
66,394 56,316 48,402
Net realized Trenwick America Re 962 6,444 2,304
investment gains Canterbury Financial Group 8 - -
(losses) Trenwick International 1,098 1,794 -
Chartwell Managing Agents (152) - -
Unallocated - 778 -
1,916 9,016 2,304
Total revenues Trenwick America Re 217,322 225,351 236,162
Canterbury Financial Group 12,234 - -
Trenwick International 120,028 83,961 -
Chartwell Managing Agents 44,233 - -
Unallocated 468 2,002 4,710
394,285 311,314 240,872
Underwriting Trenwick America Re (39,118) (3,167) 6,628
profit (loss) Canterbury Financial Group 974 - -
Trenwick International (10,946) (2,432) -
Chartwell Managing Agents (13,817) - -
(62,907) (5,599) 6,628
Interest expense Trenwick America Re 112 6 -
and minority Canterbury Financial Group 76 - -
interest Trenwick International 4,513 3,434 -
Chartwell Managing Agents - - -
Unallocated 14,177 10,216 9,814
18,878 13,656 9,814
Income (loss) before Trenwick America Re 4,369 44,320 52,644
income taxes and Canterbury Financial Group 2,659 - -
extraordinary item Trenwick International 1,171 6,977 -
Chartwell Managing Agents (9,537) - -
Unallocated (19,882) (8,260) (5,114)
(21,220) 43,037 47,530
Income tax (benefit) Trenwick America Re (3,104) 9,644 12,514
expense Canterbury Financial Group 979 - -
Trenwick International 204 1,341 -
Chartwell Managing Agents (2,519) - -
Unallocated (5,732) (2,740) (1,273)
(10,172) 8,245 11,241
Income (loss) before Trenwick America Re 7,473 34,676 40,130
extraordinary Canterbury Financial Group 1,680 - -
item Trenwick International 967 5,636 -
Chartwell Managing Agents (7,018) - -
Unallocated (14,150) (5,520) (3,841)
(11,048) 34,792 36,289
Total investments Trenwick America Re 1,209,923 792,868
and cash Canterbury Financial Group 104,216 -
Trenwick International 215,846 211,599
Chartwell Managing Agents 196,313 -
Unallocated 23,561 744
1,749,859 1,005,211
Total assets Trenwick America Re 1,837,261 1,028,569
Canterbury Financial Group 262,233 -
Trenwick International 406,430 353,079
Chartwell Managing Agents 533,455 -
Unallocated 201,220 10,613
3,240,599 1,392,261
</TABLE>
57
<PAGE>
Brokers and Ceding Companies
During the year ended December 31, 1999, Trenwick America Re received
approximately 61% of its gross written premiums from three reinsurance brokers
of which AON Reinsurance Agency accounted for approximately 37%, Guy Carpenter
accounted for approximately 16% and E.W. Blanch accounted for approximately 8%.
In 1998, Trenwick America Re produced approximately 37%, 10% and 10% of its
gross written premiums from three reinsurance brokers; AON Reinsurance Agency,
Peglar and Associates, Inc. and Willis Faber, respectively. In 1997, Trenwick
America Re produced approximately 41%, 14% and 10% of its gross written premiums
from three reinsurance brokers; AON Reinsurance Agency, Willis Faber, N.A. and
G.J. Sullivan, respectively.
Two reinsurance brokers accounted for approximately 13% of Trenwick
International's 1999 gross written premiums of which AON Reinsurance Agency
accounted for approximately 8% and Alexander Forbes accounted for 5%. In 1998,
Nelson Hurst and AON Reinsurance Agency accounted for approximately 15% and 12%
of gross written premiums, respectively.
Trenwick's concentration of business in the U.S. reinsurance market through a
small number of sources is consistent with the concentration of the property and
casualty broker reinsurance market, in which a majority of the business is
written through the top ten largest brokers in the reinsurance industry.
Contrary to Trenwick America Re's concentration, Trenwick International's
business is produced from a variety of sources including insurance and
reinsurance brokers.
During the year ended December 31, 1999, Trenwick America Re received
approximately 26% of its gross written premiums from three ceding companies of
which Duncanson and Holt accounted for approximately 12%, American International
Group accounted for approximately 7% and CNA Insurance Companies accounted for
approximately 7%. In 1998, Trenwick America Re produced approximately 16%, 12%
and 10% of its gross written premiums from three ceding companies: Duncanson and
Holt, American International Group and Fort Washington Holdings, respectively.
In 1997, Trenwick America Re produced approximately 11%, 11% and 10% of its
gross written premiums from three ceding companies: American International
Group, Canal Insurance Company and Travelers Group. No one ceding company
accounted for more than 3% of Trenwick International's gross written premium in
1999 and 1998.
Loss of all or a substantial portion of the business provided by these brokers
and ceding companies could have a material adverse effect on the business and
operations of Trenwick. Trenwick does not believe, however, that the loss of
such business would have a long-term adverse effect because of Trenwick's
competitive position within the reinsurance market and the availability of
business from other brokers and ceding companies.
Managing General Agencies
In 1999, Canterbury Financial Group wrote approximately 66% of its gross
written premiums through four managing general agents as follows: HDR Insurance
Services (23%), Florida Intracoastal Underwriters, Ltd. (19%), Inter-Reco, Inc.
(13%), and Professional Insurance Underwriters, Inc. (11%). Loss of all or a
substantial portion of the business provided by these managing general agencies
could have a material adverse effect on the business and operations of Trenwick.
58
<PAGE>
Note 18
Unaudited Quarterly
Financial Data
Summarized unaudited quarterly financial data is as follows:
<TABLE>
<CAPTION>
(in thousands
except per share data) 1999 1998 1997
----- ---- ----
<S> <C> <C> <C> <C>
Quarter ended
Earned premiums December 31 $141,467 $63,612 $45,414
September 30 58,608 65,161 43,723
June 30 66,071 70,964 47,105
March 31 58,968 45,824 53,914
Net investment December 31 26,207 14,639 12,372
income September 30 13,047 14,317 12,178
June 30 13,317 14,976 12,123
March 31 13,823 12,384 11,729
Net realized December 31 (1,075) 7,572 388
investment September 30 (38) 184 -
gains (losses) June 30 523 540 1
March 31 2,506 720 1,915
Income (loss) before December 31 (2,392) 11,329 9,122
extraordinary September 30 (22,426) 5,243 8,773
item June 30 5,665 8,975 8,593
March 31 8,105 9,245 9,801
Basic income (loss) December 31 (.16) 1.03 .77
before extra- September 30 (2.15) .45 .74
ordinary item June 30 .54 .75 .72
per share March 31 .75 .78 .90
Diluted income (loss) December 31 (.16) 1.02 .75
before extra- September 30 (2.15) .44 .73
ordinary item June 30 .53 .74 .71
per share March 31 .74 .77 .81
</TABLE>
Amounts for 1999 reflect the results of Chartwell, accounted for as a purchase,
from October 27, 1999, the date of acquisition. Amounts for 1998 reflect the
results of Trenwick International, accounted for as a purchase, from February
27, 1998, the date of acquisition. In the quarter ended March 31, 1997, Trenwick
had an extraordinary loss on debt redemption of $1,037,000, or $0.09 per basic
share, which was net of a $558,000 income tax benefit.
Note 19
Subsequent
Event
On March 1, 2000, Chartwell Re Holdings fully redeemed its 10.25% Senior Notes
due 2004 at a redemption price of 102.56% of par value. The net balance of these
notes as of December 31, 1999 was $40,075,000.
59
